Download The Evolution of Water Law Toward the Efficient Allocation of Water

Wesleyan University
The Honors College
The Evolution of Water Law Toward the Efficient
Allocation of Water Rights:
An Analysis of England and California
by
Evan Hazelett
Class of 2013
A thesis submitted to the
faculty of Wesleyan University
in partial fulfillment of the requirements for the
Degree of Bachelor of Arts
with Departmental Honors in Economics
Middletown, Connecticut
April, 2013
For my friends, who make me laugh. For mom and Peter, who always support me to the fullest. For my brother, who knows me best. And for my father, I miss you. Together, we become better people. Contents CONTENTS i INTRODUCTION 1 CHAPTER 1 Introduction 15 Introducing the Economics of Water Law 16 Some Basic Considerations 16 Farmers and Water: A Few Simplified Examples 18 Desirable Outcomes: Efficiency and Distributional Welfare 25 The Application of Governance Structures 27 Transaction Costs in Theory 33 Bargaining for Rights in a World Without Transaction Costs 34 Bargaining for Rights in a World Full of Transaction Costs 48 Conclusion 56 CHAPTER 2 Introduction 59 Governance Through the Ancient Use Doctrine 63 A Brief Discussion of the Relevant Conditions 63 What the Ancient Use Doctrine Is and How It Can Be Applied 67 Russell v. Handford 69 Luttrel’s Case 76 Sury v. Pigot: Doctrinal Shifts 78 Governance Through the First Occupancy Doctrine 83 The Influence of Economic Growth and William Blackstone 83 How First Occupancy Differed from the Ancient Use Doctrine 87 Bealey v. Shaw 88 Additional Clarifications and Considerations 92 Governance Through the Rule of Reasonable Use 95 The Conditions That Necessitated a New Rule 95 Embrey v. Owen 97 Conclusion 103 -­‐i-­‐ CHAPTER 3 Introduction 106 Nineteenth Century California Water Law 110 An Overview of Early California Water Rights 110 Growing Importance of Prior Appropriation 114 Limitations on Prior Appropriation 116 The Gold Rush: The Birth of Prior Appropriation 122 The Conditions That Necessitated A New Rule 122 Riparian-­‐Appropriator Conflict: The Case of William Ware 127 A Distributional Argument, Perhaps? 129 Growing Conflict: Prior Appropriation v. Riparian Rights 134 Applying Rules Differentially 134 Lux v. Haggin 136 Continuing Conflict 138 A Model For Determining the Efficiency of Rulings 142 Conclusion 151 CHAPTER 4 Introduction 154 The Importance of Administrative Oversight of Water Rights 157 The Appropriative Water Right 157 The Alternatives 160 Reasonable Use 160 Decentralized System of Appropriative Permitting 167 Article X, Section 2 Joslin v. MMWD Should the Government Be Involved At All? IID v. SWRCB The Public Trust Doctrine and Environmental Regulation National Audubon Society v. Superior Court The Public Trust Doctrine and Distributional Welfare A Final Thought The Importance of Transfers MID and USBR Two Final Provisions of Transfer Law -­‐ii-­‐ 168 170 177 181 187 189 195 197 199 202 206 Conclusion CONCLUSION BIBLIOGRAPHY 208 210 224 -­‐iii-­‐ Introduction Water is the resource of life. Its significance to us as organic beings is paramount. It pervades everything we are and everything we do. Water is in our drink, it is in our food, and it comprises the majority of our body mass. Water is in our clothes, it is in the wood used to construct our homes, it is in the earth we walk upon every day, and it permeates the atmosphere and the air we breathe. Without food, humans can survive for up to a month; without water, we die in a matter of days. Such a delicate and simple body of molecules, water is so transparent and pure, so omnipresent, so tangible and yet so fleeting, and so astronomically important for life as we know it. Water, the fluid that pours out of holes in the ground and into our mouths at the push of a button. We have found ways to master the provision of water, and yet still water masters us. With it, we are whole. Without it, we are lost. The thought is humbling. It brings us back to our roots, to a place where we are not but flesh and blood. It is truly a fragile existence we lead, an animal existence, wholly dependent upon the materials and the nutrients of the earth. Water’s role as the resource of life has been, and still is, reflected in custom, religion, and social order. Its existence has been raised to the level of divinity, and its uses have been central to the social fabric of societies. Yet while -­‐1-­‐ water has often existed as a public good, a natural resource, free to all, it also has a substantial history of privatization and management. This dual character of water as a free, public good by right, gifted by the divines, as well as a privately owned, managed resource predates modern society. Water’s dual nature was not lost on our predecessors, whose ancient rules and customs pertaining to water still dominate traditional societies today. Whether for communities governed by traditional Jewish water law, traditional Islamic water law, Zimbabwean indigenous water law, Bihar Indian water law, or Australian aboriginal water law, water was and still is a centerpiece of the community and social relations. It connected everyone through a shared spiritual and social identity. It was a gift of divine beneficence, a human right shared by all. At the same time, because of scarcity, water was managed by these traditional water laws, which governed ownership of water holes, wells, and sharing procedures. Still, anyone in need could at almost any time attain access to someone else’s water source simply by asking (Salzman, p. 6-­‐10). This balance between understanding water as a human right and public good and as a tradable and manageable resource is a dilemma these traditional societies grappled with. Water also dominated social relations in Ancient Rome, and its provision was an important economic and political puzzle that much time, money, and effort was spent tackling. The Roman aqueducts are one of the most amazing infrastructural feats of that era. More than that, they stand as a symbol of the magnificent importance of water, past, present, and future. These great -­‐2-­‐ structures brought water into the city for three uses: public use in the lacus, the public basins, which was a free service; private use, supplied by a private pipe service, for which one had to pay a special tax, a vectigal; and the bath houses, which were indoor, public bathing pools (Salzman, p. 11-­‐15). Both the bath houses and the lacus were utilized as communal meeting places. Water was a central driver of social engagement, and it permeated one’s daily activities. This society, too, tried to maintain the balance between water as a free public good and as a privately manageable resource. Water from the lacus was, by right, free, and use was limited only by the weight of water and the effort one had to exert carrying it around. On the other hand, the private service was taxed, an amount that varied based on the size of one’s supply pipe nozzle (Salzman, p. 14). Water, in this form, was a status symbol, reserved to the wealthy few. There was also a political message associated with water. The public fountains, which were numerous and lavishly decorated, maintained an omniscient imperial presence, reminding the Roman people that they received their water, their well-­‐
being, through the generosity and permission of the emperor. How to effectively secure and manage the use and allocation of water is a recurring theme throughout history. Should it be privately secured and distributed? Should the government play a role in the provision of water? A few millennia after the peak of the Roman Empire, in the late 19th century, both London and New York City were dealing with these issues. In London, there were a handful of private companies allocating water to the people. A cholera outbreak through the water supply due to negligent management, however, -­‐3-­‐ caused many to wonder whether private ventures should be granted the power to manage water. Eventually, the Metropolitan Water Board took over operation of the water companies and provided free water through public fountains, much like in Ancient Rome. New York City also grappled with the hardships associated with the governance of water use and allocation. There were certainly public wells, but with growing urbanization and industrialization, and, resultantly, growing sanitation management problems, a number of private allocation schemes propped up, including one that was sanctioned by the local government. This latter one in particular, the Manhattan Company, which later became the Chase Manhattan Bank, through corruption, greed, and lack of concern, let the water infrastructure remain in a state of decay. A cholera outbreak due to negligent management, similar to that in London, finally convinced the government to provision water publicly through the Board of Water Commissions (Salzman, p. 15-­‐22). It is clear that, even in the not-­‐so-­‐
distant past of both the United States and England, how to effectively govern water was an ever-­‐present issue for society to address. These questions of water management are still essential in contemporary society. We live in an era of massive population growth with greater demands for food, higher standards of living than the world has ever seen before, and increasing urbanization and industrialization. We are putting greater and greater pressure on our freshwater resources, especially surface water, which, when compared to the composition of water worldwide, is a very fragile resource. Freshwater comprises only 2.5% of all the world’s water, and only -­‐4-­‐ 0.4% of that 2.5% is surface and atmospheric water (“Global Water Security”, p. ii). The surface water we can access is extremely limited, and our growing population, increasing incomes, and thus increasing demand for food and water-­‐
intensive foodstuffs such as meat, is pushing us toward the brink of water crises worldwide. Many of us in the developed world view water management as an issue relegated to the third world, associating water strife with extreme poverty and sickness. The truth is that intelligent water management is essential even for those in the developed world. Water is a precious natural resource that has endless applications and must be managed effectively. Despite widespread reverence for water as something divine, this does not eliminate the necessity of its management. Like any natural resource, water is subject to the tragedy of the commons. Without a governance structure for water as a resource in an era of powerful technology and large populations, our water resources would easily be overrun by poor management, wasteful practices, and excessive pollution. Any society must have rules governing the use and allocation of water. Understanding the importance of governing water effectively, I wanted to know how governments both past and present have dealt with issues of water management. Water has wide economic applications, but like any resource those applications are limited or facilitated by the laws governing the use of water. Having a system of law is important in many regards, one of which is the facilitation of economic growth and innovation by protecting investments in the utilization of natural resources. Yet there is not one strict form the law must -­‐5-­‐ take. While there are some fundamental laws that withstand the test of time, there are still many other laws that are changing or evolving as new conditions arise, such as advances in technology, cultural transformations, changing values or norms of behavior, or changing natural conditions. With respect to water, I wanted to know why certain systems of water law have been constructed, both past and present, how courts and lawmakers have sought to deal with issues of water allocation through the application or transformation of the law, and whether there were conditions that seemed to bring about one form of law over another form of law. Law is central to the functioning of any economy, and thus law is central to the allocation of water as a resource. What I look at in this thesis is, put most simply, the management of water through various structures of law. Specifically, I will be looking at the English common law of water rights from the late sixteenth century through to the early nineteenth century, the California common law of water rights in the second half of the nineteenth century, and the modern era of California water law from 1913 through to the present. California has a long history of contentious debate concerning water law, water use, and the allocation of water rights. As an arid western state, California has always faced difficult questions of water allocation, given greater demands for water than the scarce resource can supply. England serves as an interesting counterpoint to California, given a relative abundance of water. Furthermore, there are many parallels between the structures of law employed in these two regions, influenced in no small part by the fact that California adopted the English common law when it earned statehood. While -­‐6-­‐ these two regions faced drastically differing natural conditions, lawmakers and courts in both regions have always dealt with the same questions of water management. What is the nature of water? How should it be managed and used? Who will have access to it and how? Will it be free or costly, privately owned or publicly distributed? What are our goals in allocating water? What rights structures should be utilized in order to best achieve our goals? The two goals with respect to the allocation of water that I will primarily discuss in this thesis are efficiency and wealth distribution. The term efficiency will be interchangeable with maximum value in ownership or use, denoting the condition that rights to water are in the hands of their highest-­‐valuing owners (HVOs). Distribution refers to the fact that different rights structures to water will ultimately facilitate a different wealth distribution as the rights to water are owned and used by different people. To whom the initial rights to water are endowed plays an important role in the ability to achieve both efficiency and distributional goals. Because of this reality, different water rights structures will be appropriate under different circumstances for achieving efficiency or distributional goals. There are numerous “types” of water: surface water, groundwater, aquifers, and oceans. This thesis will focus on surface water rights. These rights are by no means the only influential rights in water management; many water users, especially agricultural irrigators around the world, rely on groundwater and aquifers. However, each source of water generally has its own set of associated water rights, and conditions that apply to one source of water may -­‐7-­‐ not apply to another source of water. Therefore, I have decided to focus my analysis on surface water rights, which are generally the most prominent and influential. Hereafter, when I write “water,” it can be assumed I am referring to surface water, which includes lakes, rivers, and streams, and all their tributaries. Water rights typically deal with rivers and streams, however lakes are also important, especially in the modern era of water rights in California where large reservoirs are integral to water management. There are two characteristics of local or regional economies that are fundamental in determining what water rights structures are most appropriate for achieving either efficiency or distributional goals: (1) the existence of high or low transaction costs to voluntary bargains for water rights; and (2) the natural and economic conditions setting the context for the use of water. In this thesis, I hope to provide compelling analytical evidence from the English common law, the California common law, and the modern era of California water law to support two major hypotheses: (1) the prevailing transaction costs to bargaining and the natural and economic conditions setting the context for the use of water are pivotal in determining which water rights structure would be the most appropriate in order to achieve specific goals with respect to the use and allocation of water; and (2) lawmakers and courts have, and should, actively facilitate the evolution of water law, in recognition of (1), implementing water rights structures that most effectively achieve the efficient allocation of water rights given the prevailing conditions mentioned in (1), with distributional goals in mind. These ideas are central to my thesis, and I will refer back to them -­‐8-­‐ constantly. It is essential for the reader to keep these in mind as he or she explores my analysis. In Chapter 1, I will explicate the theoretical framework through which I will be analyzing English and California water law, giving greater meaning and depth to my two hypotheses. I begin by introducing the core economic concepts of this thesis through various examples. These examples are generally simplified explorations of the fundamental problems faced by water users along the same stream. I hope that these examples will set the stage for the reader in a comprehensible way, getting the reader thinking about water problems, how various issues may arise along waterways, and how these issues may be solved. I will also introduce the concept of transaction costs in this first section, suggesting different types of transaction costs and how they may arise in different contexts. I hope to show how transaction costs play an essential role in determining what rights structures may be more or less effective in achieving prescribed goals. After introducing the core concepts of the thesis through simplified examples, I will transition into an explanation and exploration of important insights provided in two seminal law and economics articles that serve as the theoretical core of the thesis. The first article is “The Problem of Social Cost” by Ronald Coase, published in 1960 (Coase, 1960), and the second is “Property Rules, Liability Rules, and Inalienability” by Guido Calabresi and Douglas Melamed, published in 1972 (Calabresi, 1972). In “The Problem of Social Cost,” Coase explores how the presence of transaction costs to bargaining for property -­‐9-­‐ rights determines whether or not an efficient bargain for property rights may be achieved after property rights are initially endowed. In a world full of transaction costs, to whom the initial property rights are endowed will affect whether or not the efficient allocation of property rights may be achieved through voluntary bargaining for those property rights. Coase contrasts the world of transaction costs with a world devoid of transaction costs, showing how, in a world devoid of transaction costs, the initial endowment of property rights does not affect whether or not the efficient allocation of property rights may be achieved through bargaining. This concept is referred to as the Coase Theorem. In fact, the efficient allocation of property rights will always be achieved in a world devoid of transaction costs, because there is nothing hindering property rights owners from reallocating all property rights to the HVOs of those property rights. Thus, in a world devoid of transaction costs, perfect efficiency may always be achieved. There is one caveat to the Coase Theorem involving the concept of effective demand. Having effective demand means that one’s utility preferences are, in fact, backed up by true economic value. I will show, in my discussion of a world without transaction costs, how a lack of effective demand causes serious implications for the Coase Theorem. However, in exploring a world devoid of transaction costs, it was Coase’s intention to describe an unrealistic world. It was in the real world, the world full of transaction costs, that Coase hoped economists would focus their analytical efforts. Calabresi and Melamed, in recognition of the fact that the real world is full of transaction costs, explored the consequences of different types of -­‐10-­‐ property rights structures in different transaction cost environments. The two main alternatives are a strict property rights regime and a liability rule. Both of these rules will be analyzed and considered extensively throughout this thesis in connection to water rights, efficiency, and distributional welfare. This large section on both Coase and Calabresi and Melamed is essential to understand, and will be drawn upon throughout the remainder of my thesis. Chapter 2 will explore the evolution of the English common law of water rights from the late sixteenth century through the early nineteenth century. For much of this period, the transaction cost environment along England’s waterways was one of low transaction costs. However, by the nineteenth century, the environment had evolved to a high transaction cost environment. The water rights rules employed during the period of low transaction costs differ drastically from the water rights rules of the early nineteenth century in a high transaction costs scenario. In support of my hypotheses, the English common law of water rights evolves appropriately considering the prevailing transaction cost environment, implementing a new water rights structure that achieves the efficient allocation of water rights. Two natural and economic conditions were also important in determining what rule would be most effective: (1) abundant rainfall across England; and (2) the primary utilization of England’s waterways for power generation, which was a very low-­‐consumption use of the water. By low-­‐consumption, I mean that very little water actually left the waterway and did not return to the stream flows. First, the existence of abundant rainfall meant that very little water from streams had to be consumed by agricultural irrigators, -­‐11-­‐ because most crops could be fed by rainfall. Second, the low-­‐consumption activity of power generation also helped to keep stream flows relatively unaltered. These conditions meant that upstream water users hardly impacted downstream water users. As I will explain in Chapter 2, this condition was also integral in determining which water rights structure would be the most effective in achieving the efficient allocation of water rights, maximizing the productive value in ownership of water rights in England. In Chapter 3, I will transition into the California common law of water rights. Due to similarities in the two cultures, intimate relations, and significant influence from English society, many US states adopted the English common law as the reigning set of laws throughout the nineteenth century, including California. As a result, California implicitly adopted English water rights. However, the economic and natural conditions in California differed greatly from those in England. There is far less rainfall in California, which meant that agricultural production, the main use for water in California, needed to consume large amounts of water from California’s relatively few rivers and streams. Moreover, as a result of the scarce rivers and streams in California, there were many productive uses to which water could be put on lands detached from rivers and streams, called nonriparian land. At times, upholding the English common law water right, called the reasonable use rule, was appropriate for achieving the efficient allocation of water rights, and at other times a new rule, the rule of prior appropriation, was better suited to facilitate efficient allocations of rights. I will show how these conditions and the prevailing transaction costs -­‐12-­‐ led California courts to apply different rules under different conditions in order to achieve the efficient allocation of water rights. In Chapter 4, I will transition from the early common law of water rights in California to the modern era of water law in California. The primary water right in the modern era is the right of prior appropriation, also known as the appropriative right. I will, first, show how this right is the most appropriate right given the conditions and transactions costs that prevail in the modern era of California. The government is extensively involved in all aspects of water management, and it is certainly capable of making mistakes. However, I seek to evidence the fact that, while the government is imperfect, the water rights structure currently in place is the “least bad” alternative and that, in fact, it is pretty effective at achieving efficiency. Second, I explain one of the primary tools employed by the government to achieve efficient allocations of water rights: Article X, Section 2 of the California Constitution. Again, the imperfect government is primarily involved in its implementation, but I believe this tool is one of the most important aspects of California water law that encourages the efficient allocation of water rights. Third, I look at the application of the public trust doctrine, which protects values in surface water for recreation, navigation, aesthetics, wildlife, ecosystem health, and fishing. I will show how voluntary bargains to protect these values would often be impossible due to transaction costs, and that the protection of the public trust by the government efficiently allocates water rights to the public at large -­‐13-­‐ when the public trust values are at stake, presuming that the public on aggregate is the HVO of the rights. Lastly, I will look at how California water law governs transfers of water rights, showing how the law is very effective at ensuring that water rights may be reallocated through transfers to their HVOs. Uses of water in California are inherently interwoven; any change in the use of water by one rights holder will almost always affect another water rights holder. Transfers of water rights are among these changes that indirectly affect other water rights holders. The way the law is structured, and the way transfer procedures are structured, capitalizes on voluntary bargains to ensure that the true HVO of the water rights at question emerges. Once again, the central concept that flows throughout all four chapters is the idea that different rights structures for water are appropriate under different conditions in order to facilitate the efficient allocation of water rights. Water law in both England and California has evolved over time as the prevailing natural and economic conditions and transaction environments have evolved in order to achieve the efficient allocation of water rights. Law and economics go hand in hand, and I hope to show how the law has adapted in the case of water rights to best serve economic efficiency in England and California. -­‐14-­‐ Chapter 1 INTRODUCTION In this chapter, I seek to introduce the economic theory behind the analysis I will be conducting in this thesis. In the first section of the chapter, I will introduce the types of issues faced by water users along waterways in their attempt to achieve efficient allocations of water rights. I hope to acquaint the reader with the types of transaction costs and conditions that can complicate these issues, as well. While water issues can get very complex, I will use simplified examples to illustrate the operation of the basic concepts I am introducing. In the second part of this chapter, after introducing the basic concepts, I will expand upon the economic theory that is central to this thesis. Using help from the works of Ronald Coase (1960) and Douglas Melamed and Guido Calabresi (1972), I will dive into two contrasting worlds: the world of zero transaction costs to bargaining and the world of significant transaction costs to bargaining. The world of zero transaction costs is not realistic, but it serves as a good point of departure for this type of analysis, representing an ideal world. Through the analysis of both worlds, I seek to show how different structures of rights to water produce different results, in terms of efficiency and distribution of wealth. The argument I seek to support, and the one that I will drill into my -­‐15-­‐ analysis throughout this thesis, is that the law of water rights has, should, and will evolve as the economic conditions and transaction costs environments pertinent to the use of water evolve, in order to facilitate the efficient allocation of water rights, moving all water rights to their highest-­‐valuing owners. INTRODUCING THE ECONOMICS OF WATER LAW Some Basic Considerations Imagine a freshwater river in the American west spanning hundreds of miles with thousands of users all vying for their share of the river flows. The river flows are limited, naturally, as all physical systems on Earth are. Each year, there is a finite amount of water that flows along the riverbed and out to the ocean. There are many different types of uses to which the river flows can be put every year. There are farmers who use the water for irrigation, all of whom together account for the largest share of water consumption. Agriculture is the largest consumer of water worldwide, accounting for roughly seventy-­‐five percent of freshwater consumption. This is no different in the American west, where there is often less rainfall than places like the northeast. Irrigation that utilizes river water is essential to these farmers, and they will certainly play a significant role in determining the fate of the river, to whom the water goes, and how much water each user is allotted. As our producers of sustenance, these farmers have no small voice when it comes to matters of water. They have also generally been around much longer than other users, their families or businesses often spanning back a hundred years or more. They are long-­‐established users, and -­‐16-­‐ will not be bargained with, or denied very easily what many of them see as an inherent right to the river water. There are also domestic users, and millions of them. The average citizen must have fresh water to drink, to wash their dishes and their clothes, and to bathe or take showers. Though not a massive source of consumption, domestic water consumption is not trivial, and it is on the rise on this river with a growing population and increasing wealth. The final major consumer of this water is industry. It usually accounts for slightly more consumption than domestic users, and it, too, is not trivial. Industry may be Nestle seeking to suck up thousands of acre-­‐feet of river water to produce chocolate milk, or to bottle up and sell as a substitute for tap water. It may be IBM distilling freshwater to an “ultra pure” state that can be used in the construction of microchips used in your iPhone. Perhaps the water is used for cleaning and maintenance in a Mercedes automobile factory. Whatever the purpose, this fresh water is an essential input in many industries. There are still other users. While they are generally not consumers of the water, they are important users: those who utilize this river for recreational purposes, and those who value it for its aesthetic beauty. Recreational users include fishers, swimmers, jet skiers, water skiers, boaters, etc. These users are many, they derive substantial pleasure from the use of this freshwater source, and they may value its preservation so much that they will pay significant sums of money to see it done. A strong conservational force can actually be the private or public sale of fishing licenses along rivers and streams. Fishing licenses can be -­‐17-­‐ so fruitful that they allow the distributor to maintain the preservation of the water source against potential competition. Those who value this river for its aesthetic beauty, or perhaps just to know that it exists, or that it is free from industrial pollution, or that it is maintained as a healthy part of the ecosystem and nutrient cycling throughout the biosphere, are also important “users.” The government, or private associations like The Nature Conservancy, often represent the desires of these “users,” given the difficulties of organizing masses of people spontaneously to give voice to this specific set of values. The potential uses for this freshwater river are numerous, as demonstrated above. This makes the governance of this resource an exceptionally difficult and time-­‐consuming task. Every individual wants their “fair share,” they will fight to keep what they already have, and they will scrap for every extra drop they can acquire. While, in reality, the issue is far more complex because of the myriad of competing uses, I will use a simple example involving one hundred farmers in order to suggest the general difficulties confronted by the users of this river. Farmers and Water: A Few Simplified Examples Imagine that one hundred farmers are the only users of the river water. They are all riparian landowners, in that their land physically borders the river, and they are cultivating all of the physically cultivable land they own. Because the river stretches for hundreds of miles, the farmers’ residences are not close to one another. Their families have all been around for generations and have been using the water for agriculture for just as long. They all need water to feed their crops, -­‐18-­‐ and they all use a lot of it. In fact, in this hypothetical, it is the case that the full extent of the river flow can be completely consumed by irrigation. As a result, the very last farmer on the river, the one closest to the mouth of the river opening up into the ocean, is literally consuming every final drop of water flowing down past his land. This final farmer, and, in fact, every farmer who has another farmer upstream from his land, is thus vulnerable to the behavior of those upstream from them. As a result, the farmers face a situation where it is not sufficient to simply say that every individual can take what they need and do what they want with the river. If this were the governing structure, in that the river was essentially a public good that these one hundred farmers could utilize at will, it is very possible that many of the farmers downstream would be left with less than the amount of water they need, and have been using, for irrigation. All of the upstream users could carelessly divert water from the river in excess of what they actually need simply because they can, or because it is more expedient, or because they have convinced themselves they deserve it, maybe because their family has been around the longest and they believe they have an ancestral right to the water, or perhaps because it eliminates the necessity to invest in water-­‐
saving technologies or engaging in careful and precise farming practices. Essentially, we would be looking at a tragedy of the commons. With no governance structure other than that which allows free-­‐for-­‐all diversion, there would be a powerful incentive to overdraw more than one needs, or more than an equal share of water from the river, perhaps even to store some away for the -­‐19-­‐ future to abate risk born of uncertainty in the volume of river flows from year to year. If everyone upstream overdraws water, everyone downstream is damaged. Excessive diversion upstream would leave those downstream with little to no water to irrigate their own crops. Such a tragedy is not desirable because excess water upstream is being put to potentially lower-­‐valued uses than it would have been put downstream. Those users downstream, who could put the excess water to more beneficial and productive use, are deprived. Where this is the case, less than the maximum possible amount of value is produced from this water. However, these parties could theoretically bargain, making all parties better off. If any one of the water-­‐deprived farmers could generate greater productive value by utilizing some of the wasted value in excess water upstream, this farmer should then be able to negotiate with one of the upstream farmers in order to acquire some of that upstream water. Both could be made better off, so it would be in the best interest of both parties to organize a transaction. The problem, then, is that transaction costs inherent in these types of negotiations arise, and may inhibit these types of mutually beneficial bargains. For instance, if the farmer with whom I negotiate to take surplus from is ten farmers upstream from me, in a lawless state, all ten farmers in between us can take whatever surplus they want from my trade. I would then have to negotiate with all ten farmers in order to give them an incentive to let the surplus flow by their land. The transaction costs to a bargain take many different forms: parties have to expend time and money finding potential bargaining partners; they have to access and pay fees to some legal apparatus, such as a court, an administrative -­‐20-­‐ body, or a law firm, in order to make the negotiation official; and they conceivably have to expend resources on monitoring and enforcement of the agreement, which I include in the category of transaction costs because they are central to determining whether or not the bargain will be beneficial overall. All parties involved have to determine accurately the benefits and costs involved in the bargain in order to know whether it will be productive or not, including what the transaction costs will be; they have to work out how to actually carry out the agreement, which might involve rearranging some internal production or administrative processes within one’s organization, or perhaps opening new lines of communication with different parties; some parties may have more business savvy, greater skill in some area, or greater understanding of what is at stake, and they may be required to spend time and effort educating another party and explaining the terms and how they are beneficial to other parties; more time and effort than would ideally be necessary might be expended if there are reasons for distrust between parties, or hesitancy to engage in a market transaction over property or to deal with administrative or legal bodies; there are costs of dealing with free riders and holdouts, which I will explain below; and, lastly, they will likely have to experience any number of these sources of transaction costs numerous times as each aspect of the negotiation is revisited, thrown out, or put on hold, this likelihood only growing with the addition of more parties to negotiations. If, after all the transaction costs are taken into account, it is determined that the bargain will still produce profit for all parties -­‐21-­‐ involved, then the transaction will take place and efficient allocation of the rights to water will result. As more and more transaction costs are added, it becomes much less probable that the trade will be worth it. There are costs involved in each one of my negotiations with the eleven other farmers. After all this, the transaction costs alone might be greater than the benefit I would receive, ultimately deterring a potentially productive transaction. All of these sources of costs would apply to every one of my negotiations with the other eleven farmers, and the fact that there are eleven farmers makes it all the more difficult. If it is too difficult, we might not be able to follow through with a bargain that could raise the productive value of the river. This is just one way in which the water might not be used most productively. Abstract from this example and one can imagine that the difficulties only become worse when there are one million farmers as opposed to just one hundred. Another “tragedy” producing inefficiency could arise with excessive pollution of the water. If there is no governance structure to legally define what can and cannot be dumped into the water, there is little incentive for upstream users to take steps to reduce pollution, such as limiting waste, dumping waste elsewhere other than the river, guarding against runoff of hazardous chemicals on their land into the river, or investing in pollution-­‐reducing or pollution-­‐
eliminating technologies. In the same way that downstream users are vulnerable to the diversion behavior of upstream users, they are also vulnerable to the polluting behavior of upstream users. In this limited-­‐governance scenario, -­‐22-­‐ downstream users will either suffer from excessive pollution or they will have to spend more than upstream users on water treatment. This will not always be a desirable scenario because there is the potential for inefficiency, in that the productive value of the river may not be maximized. When the polluters are endowed with the initial rights to pollute the water but they are not the true HVOs of the rights, there are potentially productive transactions that would often be deterred. If the first farmer on the river produces pollution sourced upstream, it damages everyone downstream approximately equally, which increases transaction costs to a likely prohibitive level. Each farmer takes what he wants from the river and treats that water only before his own use. The rest of the water remains polluted, injuring every downstream farmer. Thus, every downstream farmer has a stake in eliminating the pollution created by the first farmer on the river. If the first farmer is not forced by the government to reduce or eliminate his pollution, the rest of the farmers could conceivably bargain with him. If the potential productive value of each of the ninety-­‐nine farmers downstream in a river without pollution is greater than the value produced by the first farmer with pollution as a by-­‐
product, in a transaction costless world, a bargain between the first farmer and all downstream farmers could make all parties better off. Similarly, if the first farmer produces more value through pollution-­‐generating activities than the damages caused to all ninety-­‐nine farmers downstream, then this first farmer is the HVO of the rights to pollution and the ninety-­‐nine farmers will not be able to buy the rights. This will, likewise, produce the efficient allocation of the rights. -­‐23-­‐ But, as I have just discussed, the world is full of transaction costs, including all those I discussed above. Moreover, the existence of free riders and holdouts will exacerbate this problem. Each farmer that is injured by the pollution would be willing to pay a certain amount to see the pollution decreased or eliminated. This means each of those farmers is receiving some benefit from decreased pollution. So it is immediately in the best interest of each farmer to try to free ride on the payments of the other farmers. If each farmer who decides to pay money to the polluting farmer receives some sort of benefit from reduced pollution, there is leftover benefit in the hands of each of those farmers. If each of them paid just a little more, they could cover the damages to some of the other downstream farmers as well. The problem is that each farmer has the incentive to become a free rider and wait for other farmers to offer to pay. Also, many farmers could free ride on a handful of farmers that desperately need zero pollution, making them pay most of the cost to the polluting farmer given that it is necessary for them, even though all the other farmers are injured as well. To add to this problem, the polluting farmer also knows that each of the other ninety-­‐nine farmers is walking away with benefits. It is in his interest to hold out until he can obtain as much of that benefit as possible. All the transaction costs, on top of the extra negotiation costs produced by free riders and holdouts, will be prohibitive often enough to eliminate many productive bargains that would raise the overall productive value of the river. -­‐24-­‐ Desirable Outcomes: Efficiency and Distributional Welfare As I have said, both of these “tragedies” are not desirable, given that the rights remain inefficiently allocated. While I have primarily been referring to efficiency as the goal in the allocation of rights, there are in fact two basic guidelines by which we can make a determination of whether or not an outcome is desirable. Desirability may be defined by efficiency goals or by distributional goals. These are not mutually exclusive but they can certainly conflict at times. Efficiency is achieved when each unit of a resource ends up in the hands of its highest-­‐valuing owner. In other words, efficiency is achieved when the total value of the goods to each of their owners is maximized. In the case of the hundred farmers, efficiency is achieved when each unit of water ends up in the hands of its HVO, whoever that may be. Or, again, in other words, efficiency is achieved when the sum of all the potential value produced by the river is maximized. Distributional goals can be achieved in any number of ways. A desirable distributional outcome is determined by our specific set of distributional goals. In the case of the farmers, it could be that we desire a certain subset of the farmers to have more wealth, in which case any outcome that brought these farmers more wealth, which would have to be taken from other farmers, would be desirable. Alternatively, we could desire complete equality, and try to divvy up the river’s total productive value equally among the farmers. Still another outcome could be that only one person has access to the water, or that no one has access and that it is owned by the state and is legally off limits. We could also desire a world where “might makes right,” in which case whatever distribution -­‐25-­‐ resulted from a complete free-­‐for-­‐all would be a good outcome. A final insight about distributional goals is that there are different ways to achieve the same distribution, and the maximized value of production, the efficient result, given a certain distributional goal is preferable. Given three different total values of production that could all potentially originate from an equal distribution of resources, it would be preferable to choose the maximum value of production if all it came down to was a simple choice. Thus, efficiency and distributional goals are each valuable for different reasons, though they are not mutually exclusive. When I dive more deeply into theory in the next section of this chapter, it will become clear how one can achieve efficiency and distributional goals simultaneously. Or, on the other hand, one might often sacrifice one goal for the other. I will show that it is often the case that distributional goals take a back seat to efficiency goals when it comes to the allocation of water rights. Distributional goals are obviously very important in the real world, and often dominate efficiency concerns in the political arena, especially if the victims of a greatly inequitable distribution are a demographic that has historically been oppressed or treated unfairly in society. Still, despite their importance, distributional goals will play a secondary role in my thesis. My thesis focuses more on efficiency: the maximized productive value of water use. You can, in fact, use the same analytical tools I will be using to determine ways in which different distributional goals might be achieved. I will often point out when distributional concerns are relevant and analyze how a certain distribution comes to fruition given a specific set of rights. That being -­‐26-­‐ said, I have found, and will argue, that efficiency has generally been the primary goal with respect to water law. But, more on that later. There are many different ways to overcome a tragedy of the commons, that of an open-­‐access resource with no access limitations or maintenance requirements in which there are many sources of inefficiency. Different solutions will be appropriate given your goals, whether they are efficiency or distributional goals, or some other goal that cannot reasonably fall under those two categories. Various rights structures can be applied to the river as a partitioned resource, providing the necessary limitations, requirements, and modes of operation that can serve to encourage the maintenance of the resource in order to fulfill particular goals. One of the insights that is central to this paper, one I have yet to fully address, is that, regardless of your goals, and regardless of the solutions you propose to the issues raised by the river example, you must face transaction costs, in all their varying forms. The Application of Governance Structures Up until now, I have been discussing the farmer example in a world where water is a public good, in that there are not private rights of exclusion to the use of water. But water use can be governed in many other ways, with rules for how rights may be attained or bought and sold, what may or may not be used to do, and how a right may be limited or expanded in the future. Any given set of rights governing the allocation, use, and distribution of water, carries with it different transaction costs for the rights owners. Many sources of transaction costs remain the same, but some change or fluctuate with the different rights -­‐27-­‐ structures that are associated with resources or courses of action. Governance structure is a term I will use consistently throughout this paper. I will use it to denote any structure of rights or institutions that governs the use of a resource, and all activities associated with the use of that resource. Institutional structure is also a broad term that includes whatever rights structure exists, the types and structure of relationships and interactions, and the enforcement and monitoring structures that may involve government or some external administration. For instance, different governance structures might have different procedural requirements, in that the farmers must access different legislative or administrative bodies and take different steps in order to earn the right to a resource through a bargain. An administrative body might require any farmer who is a party to a negotiation to complete lengthy and arduous documentation of their activities for some predetermined length of time subsequent to the bargain in order to maintain the right earned through that bargain. Different governance structures might also make communication more or less difficult or favorable between parties to a bargain, setting the stage with different procedures that are necessary to follow before, during, and after contacting other farmers, the monitors, law enforcement, the courts, or the administrative body. All of these are significant sources of transaction costs, which vary with different governance structures. Some governance structures might necessitate low enough transaction costs that most bargains occur more easily, while other governance structures might require many hurdles to leap over in order to -­‐28-­‐ finalize a transaction, which could ultimately deter many potentially productive bargains. Governance structures can take shape through markets (i.e. bargaining for rights) or through the administrative construction and enforcement of rights. Chapter 4 shows more of the latter, although Chapters 2 and 3 focus primarily on market transactions. Many of the transaction costs I highlighted earlier apply to all forms of governance structures. However, when the government gets more heavily involved, as it does in the modern era of California water law, different forms of transaction costs associated with administrative activities begin to emerge. When two parties to a transaction engage in negotiations, the HVO of the rights at question will naturally emerge through a voluntary bargain. When the government acts as a central planner in an effort to determine unilaterally the HVOs of rights at question, there is great room for error. When there are errors made in valuations by the government, the government might pursue allocations of property rights that are in fact inefficient. As I will show in Chapter 4, the California administrative structure does, at times, engage in central planning activities, but, for the most part, it does a good job of capitalizing on the power of the market to facilitate the natural emergence of the HVOs of property rights. When the government does engage in central planning activities, I will seek to evidence the imperfections of this structure, but simultaneously show that the existing structure is preferable in comparison to the alternative market structures. -­‐29-­‐ To provide an example, I want to focus on only a small sample of the one hundred farmers example I used above. Recall the localized problems faced by eleven farmers where I want to bargain with an upstream farmer for some of the water he is putting to a very low-­‐value use. Remember that I have to reckon with the ten farmers in between us who could take water acquired through my bargain. If I want to strike a deal with all eleven farmers, I will face all the transaction costs I discussed in the previous exploration of this example. But, depending on the governance structure implemented by the government, there may be greater or fewer transaction costs, making it more or less likely that we can strike a successful deal. For instance, say each one of us was endowed with the right to some volume of the total river flow, and that they only way to alienate us from this right would be to buy it from us. Then, I would not have to bargain with the ten farmers in between at all, because they would already be required by law not to take any of the surplus water flowing to me from the upstream farmer with whom I am negotiating. This would eliminate transaction costs with these ten farmers, radically reducing the overall transaction costs, potentially making viable a deal with my negotiation partner that might have otherwise been deterred by steep transaction costs. On the other hand, the governance structure could significantly raise my transaction costs. For one, the governance structure could regress to a state where water is treated as a free-­‐access public good, which would again raise my transaction costs to bargaining. Or, instead, private rights to water could be maintained, but instead the government could require additional steps in the -­‐30-­‐ bargaining process in order to make such a transaction official. I could be forced to hold a public meeting to alert to everyone that I was going to be buying water from an upstream source. I might be required to alert everyone in the vicinity of my trading partner of the bargain, to address any comments or concerns about the trade, and perhaps even to involve myself in a third-­‐party arbitration hearing to adjudicate complaints. There is any number of requirements that the government could tack on to a transaction in order to make it official, which could raise transaction costs. This, in turn, would decrease the probability that I could successfully carry out a bargain for water rights. These costs will vary in intensity depending upon the specifics of the governance structure that is implemented. If the costs associated with the governance structure are raised above the benefits I will receive from the bargain, it will not be in my best interest, or in the interest of efficiency, to carry out the transaction. In this way, transaction costs, which extend to the costs of operating within various governance structures, again, can deter potentially productive bargains. There are also sources of transaction costs that will exist regardless of the specific governance structures instituted. Attached to the physical, cultural, and economic realities of the river economy and the farmers along it are a multitude of sources of transaction costs that vary region by region and will exist to an extent no matter the type of governance. For instance, the farmers along the river in my hypothetical are far away from one another. Traveling to another farmer’s property is costly. Trust may be undermined by the difficulty of actually being able to access other farmers’ lands, to engage in mutual monitoring of one -­‐31-­‐ another’s behavior, to engage in community activities together, and to exist in the same physical space generally. Further, there are often cultural factors, such as norms of behavior or morals that are sources of costs to whatever transactions may occur. These farmers might be the sorts of individuals that attach a lot of personal value to their land or to certain types of technology or interactions, making it more difficult to bargain or transact with them. Lastly, the state of the economy along this river might be one of general poverty. Under such conditions, it is unlikely that the farmers will have access to all modern forms of communications technology, their ability to travel will be limited, and their willingness to bargain for their rights or to abide by or submit to certain governance structures might be reduced due to a fear of going bankrupt or losing what little they have. For instance, let us again return to my previous example, given private property rights to volumes of water in the river. The only person I have to negotiate with is the farmer selling me his water. If this farmer is anti-­‐
government or generally has a distaste for the buying and selling of land; if he is physically far away from me, making it more difficult to contact and stay in touch with him, to engage in mutual monitoring of one another’s actions, and to trust one another; if he has outdated diversion technology that is difficult to maneuver in order to release the volume of water bargained for into the river; and/or if he has a cultural or spiritual belief about how water should be used, requiring time and effort to convince him that my use is reasonable given his beliefs, the -­‐32-­‐ transaction costs to bargaining will increase. Every time transaction costs increase, the probability of a bargain being beneficial and productive decreases. There are various alternatives that can serve as governance structure solutions to the bargaining problems faced by users along this river. They involve instituting property rights or liability rules that govern the use, allocation, and distribution of the river water. I discussed property rights briefly above, and I will get into them, as well as liability rules, more below, using more examples to illustrate how they work. Property rights and liability rules can be instituted both for efficiency and distributional goals, as will be seen in the next section. I will use the insights and works of Ronald Coase (1960) and Guido Calabresi and A. Douglas Melamed (1972) to explicate the usefulness of property rights and liability rules, the issues that must be considered, and the obstacles that will arise. TRANSACTION COSTS IN THEORY In “The Problem of Social Cost” (1960), Ronald Coase was able to show that transaction costs are of central importance to issues of resource management under various property rights structures and liability rules. The Coase Theorem, though not given that name by Coase himself, was derived from Coase’s fundamental insights, serving as a backdrop for the world of transaction costs. It is essentially the “ideal state” of transaction cost economics, the analog of zero friction in physics. It shows us how the world would operate under conditions of zero or negligible transaction costs. Transaction cost economics is nothing more than the economics of transaction costs. It seeks to understand economics at the -­‐33-­‐ level of the transaction, taking into account the various costs posed by different transactions, the various attributes of alternative governance structures, and how these may affect or drive economic behavior and the development of governance structures and institutions. Calabresi and Melamed elaborate, in a way, on the groundwork Coase laid. They explain how various “entitlements,” the term they use to discuss rights, serve to govern the use of a resource, and they show how transaction costs play a prominent role in decisions about where entitlements will rest, both initially and ultimately. Entitlements are the placement of rights to a resource, rights to carry out a specific action, or liabilities to compensate victims of actions at the hands of one party or another, when the resource or action would otherwise be governed by “might makes right” in the state of nature. These can be as varied as the property right to own and reside inside a house, the liability to pay the victims of noise pollution you produce, or the right to freedom of speech. Recall the discussion of goals above. Depending upon your goals, certain entitlements will be appropriate and others inappropriate or inefficacious. My goal, to reiterate, is to link the efficient allocation of property rights to water to various governance structures in differing transaction cost environments. First: Coase, and the world of the Coase Theorem. Then: Calabresi and Melamed, and the world of transaction costs. Bargaining for Property Rights in a World Without Transaction Costs In any economic setting, we find ourselves confronted with an infinite array of choices and possible outcomes. Almost every time we choose to act in order to -­‐34-­‐ produce a certain outcome, and we must interact with the world or other people, we are faced with the associated transaction costs of carrying out the action we have chosen to pursue. These transaction costs are often influential in our decision-­‐making process, pushing us in one direction or another. This idea encompasses all decisions, and it is central to transaction cost economics. While significant transaction costs are often a reality in any economic setting, and will be the focal point of this paper, it is worth first explaining the Coase Theorem, which operates in a world of zero or negligible transaction costs. It is a good point of departure, and helps us shed the excess baggage that accompanies most transactions to lay bare the transaction in its simplest form. It is useful, then, to contrast this world with the real world, where transaction costs are almost always prevalent and significant. Coase (1960) showed, by way of example, how zero or negligible transaction costs should affect transactions; that is, they should not affect them at all. It is so frighteningly simple an idea yet so marvelously clever. He began with an example of a farmer and a cattle-­‐rancher with adjacent property. The cattle-­‐rancher’s cattle graze widely and cannot be easily contained so they often spill over into the farmer’s land and ruin some of his crop. Coase explicates both the case where the cattle-­‐rancher is legally liable to pay the farmer for any damage his cattle cause to the farmer’s crops, that is, where the farmer has the property right to be free from damages (the liability scenario), and the case where the cattle-­‐rancher is not legally liable to compensate the farmer for damages, that is, where the farmer does not have the property right to be free -­‐35-­‐ from damages, or, alternatively, the rancher has an entitlement to impose the damages (the no-­‐liability scenario). In a world deficient of transaction costs, Coase shows that it will not matter, in terms of efficiency, whether a liability or no-­‐liability system is implemented. The same total value of production will result either way, and all resources will end up in the hands of their highest-­‐
valuing owners. While Coase used a farmer and a cattle-­‐rancher, I will use a water example to illustrate what Coase showed, one involving two farmers on a river with adjacent riparian land. I can use both a liability scenario and a no-­‐liability scenario, starting with a no-­‐liability scenario. Imagine that the activities of the upstream farmer pollute the river, with increasing marginal pollution associated with every extra acre that is added to his total cultivated area. Each additional unit of marginal pollution more causes harm to the agricultural production of the downstream farmer due to polluted water, which increasingly reduces his crop yield. The upstream farmer is liable to compensate the downstream farmer for the damages imposed due to the pollution. Suppose that one acre of cultivation on the upstream farm causes $100 worth of losses on the downstream farm due to water pollution, two acres causes $300 in damages, three acres causes $600 in damages, and four acres causes $1000 in damages. One acre also produces $200 in profits for the upstream farmer, two acres produces $400 in profits, three acres produces $700 in profits, and four acres produces $950 in profits. I have organized these numbers into Table 1 to help make this example easily comprehensible. Net social wealth is merely the net -­‐36-­‐ benefit of producing at a given level of output, subtracting total damages from total profits. Output is measured in acres of cultivated land. Profits, damages, and net social wealth are all measured in dollars. Table 1 Output 0 1 2 3 4 Marginal Profits 0 200 200 300 250 Total Profits 0 200 400 700 950 Marginal Damages 0 100 150 250 400 Total Damages 0 100 250 500 900 Net Social Wealth 0 100 150 200 50 In the first scenario, a no-­‐liability scenario, the upstream farmer is initially endowed with the rights to pollute the water, and will only increase his production so long as he finds it profitable. Further, he will never be legally obligated to pay for damages caused by his pollution. Up through four acres of cultivation, the upstream farmer still finds it profitable to cultivate land. Through three acres of cultivation, the upstream farmer is the HVO of the rights to pollute the water. The marginal profits produced at each acre of cultivation through three acres are greater than the marginal damages at each acre of cultivation. However, at exactly four acres of cultivation, the marginal damages to the downstream farmer are $400 whereas the marginal profits for the upstream farmer are only $250. Therefore, the downstream farmer is the HVO of the right to pollute water at the fourth acre of cultivation. The upstream and downstream farmers can, thus, engage in a mutually beneficial bargain whereby the downstream farmer buys this marginal right to pollution from the upstream farmer. The most the downstream farmer would be willing to pay for this right is -­‐37-­‐ $400, while the least the upstream farmer would be willing to accept is $250. The downstream farmer can buy the right, then, for some price in between $250 and $400. For example, he could buy the right for $300, making the upstream farmer better off at that marginal acre of cultivation by $50 ($300 in marginal profits -­‐ $250 in marginal profits) and himself better off at that marginal acre of cultivation by $100 ($400 in marginal damages -­‐ $300 in marginal payments). Together, $50 plus $100 in benefits produced from bargaining for the upstream and downstream farmers, respectively, equals $150 in total benefits from bargaining, increasing the net social welfare from $50 to $200. The new total net social welfare is shared evenly between the farmers, each with $100 in benefits. The total “damages,” including all marginal damages from three acres of cultivation plus the downstream farmer’s payments to the upstream farmer for the right to pollute water at four acres of cultivation, are reduced to $800 and the total profits are increased to $1000. All marginal rights to pollute end up in the hands of their HVOs, and the value of these rights in use is maximized; the efficient allocation of all rights is achieved. In order to add nuance to this situation, imagine for a moment that it would cost $600 for the upstream farmer to invest in pollution-­‐eliminating technology. Under this no-­‐liability scenario, because the upstream farmer is not legally required to compensate the downstream farmer for damages caused by pollution, the upstream farmer would not voluntarily invest in this technology. However, the downstream farmer would find it very beneficial to offer to pay for this technology for the upstream farmer. At four acres of cultivation, without a -­‐38-­‐ bargain the total damages would be $900. With a bargain, the least the damages could be reduced to in total is $750. The upstream farmer would accept at minimum $250 for the right to pollute water at four acres of cultivation. Even if the upstream farmer accepted $250 for the right, damages would still be $750 ($500 in damages from pollution + $250 in payments by the downstream farmer), which is greater than the $600 it would cost to pay for the pollution-­‐
eliminating technology. Therefore, it would benefit the downstream farmer by $150 to pay for the technology as opposed to engaging in a bargain. However, eliminating the damages from pollution would mean that the upstream farmer would gain only $250 in marginal profits from four acres of cultivation, earning $950 in total profits, as opposed to gaining $300 in marginal profits on that acre from a bargain, earning $1000 in total profits. Thus, the upstream farmer would only agree to the technology solution if his total profits would be increased. The downstream farmer benefits by $150 from the technology solution, which is $100 greater than the $50 benefit from a bargain, so the downstream farmer has some room to negotiate. He could, for example, pay for the $600 technology solution as well as pay $75 directly to the upstream farmer. This would bring the upstream farmer’s total profits to $1025, which is $25 greater than his profits from a bargain. It would also bring the downstream farmer’s total “damages” to $675, which reduces his total damages from those associated with a bargain by $75. This is a less obvious result, although it achieves a similar outcome. While rights are not directly bargained for, it is because the downstream farmer is the -­‐39-­‐ HVO of the right to pollute water at the fourth acre of cultivation that induces this farmer to pay for pollution-­‐eliminating technology. In effect, the downstream farmer still achieves the efficient outcome, eliminating pollution at the acre at which he values the right to pollute the most. The only practical difference is that he found a cheaper way to produce this result, which resulted in greater total benefits for both the upstream and downstream and a greater net social welfare of $350 ($1025 in profits -­‐ $675 in damages) as opposed to $200. This produces $225 in total benefits for the downstream farmer (because of $675 in damages as opposed to $900) and still $1025 in profits for the upstream farmer for a total of $1250 in total benefits. In a liability scenario, the downstream farmer is initially endowed with the rights to pollute the water, and, thus, the upstream farmer is liable to pay for the damages his pollution causes; he is not free to pollute at will. In this scenario, too, with a lack of transaction costs, efficiency will be achieved, the total value of production will be maximized, and the resources will still end up in the hands of their HVOs. The upstream farmer is still the HVO of the right to pollute the water through three acres of cultivation. In this scenario, however, he must bargain with the downstream farmer in order to gain those rights. At one acre of cultivation, the upstream farmer values the property right at $200 (reflected in marginal profits) and the downstream farmer values the right at $100 (reflect in marginal damages); at two acres, their respective values are $200 and $150; at three acres, their respective values are $300 and $250; and at four acres, their respective values are $250 and $400. Knowing these values, the farmers could -­‐40-­‐ engage in mutually beneficial bargains for each marginal right. For example, the upstream farmer could pay the downstream farmer $150 for the right at one acre, earning both parties $50 in benefits; $175 for the right at two acres, earning both parties $25 in benefits; and $275 for the right at three acres, earning both parties $25 in benefits. The upstream farmer would pay nothing for the right at four acres because his profits are far less than the damages to the downstream farmer, making the downstream farmer the HVO of the right to pollute. Therefore, the downstream farmer will sell the right to pollute through three acres of cultivation and keep the right to pollute at four acres. In terms of efficiency, total value of production, and net social welfare, this scenario produces exactly the same result as the no-­‐liability scenario. The downstream farmer would concede $500 in damages from pollution through three acres of cultivation. However, he is paid a total of $600 through bargains with the upstream farmer, which leaves him with $100 in benefits from bargaining. The upstream farmer produces $700 in profits and has to pay $600 for the rights, earning him $100 in benefits. Together, the farmers’ benefits equal a net social welfare of bargaining of $200, the same result as the no-­‐liability scenario. The difference between these outcomes, however, is in the distribution of wealth reflected by the value of the rights to pollute. In the no-­‐liability scenario, the upstream farmer makes $1000 in total profits after bargaining for the right to pollute at four acres ($700 in profits from cultivating three acres plus $300 in payments from the downstream farmer extracted from the $400 value of the -­‐41-­‐ right to pollute at four acres). In the liability scenario, the upstream farmer receives total profits of $100 ($700 in profits from cultivating three acres minus $600 in payments to the downstream farmer for the rights), and therefore only $100 of the total value produced by the rights. In the no-­‐liability scenario, the downstream farmer benefits by $100 compared to cultivation through four acres (subject to $800 in total damages as opposed to $900 in total damages). In the liability scenario, the downstream farmer keeps the right to pollute at four acres, which he values at $400. This farmer also is paid $600 by the upstream farmer for the rights to pollute through three acres of cultivation. In total, the downstream farmer profits by $1000. Thus, in both scenarios, the total value of the rights is maximized at $1100 ($1000 + $100). The difference is that, in the no-­‐liability scenario, the upstream farmer holds $1000 in value, whereas in the liability scenario, the downstream farmer holds $1000 in value. Depending upon the scenario, one farmer holds a greater distribution of the wealth produced by the rights to pollute. The total value of the rights is still maximized, however, the rights end up in the hands of their HVOs, and the efficient result is achieved. I would like to consider, lastly, the situation in which there is a pollution-­‐
eliminating technology that costs $600. The upstream farmers will definitely want to invest in this technology. While the $600 investment is equivalent to the payments the upstream farmer would have to pay for the pollution rights through three acres of cultivation, the upstream farmer would now be able to cultivate four acres because of the elimination of pollution. The upstream farmer would produce $350 in total profits, then, as opposed to $100. Eliminating -­‐42-­‐ pollution would mean that the downstream farmer would only benefit by $900 in reduced damages as opposed to $1000 in reduced damages. However, while the downstream farmer holds the rights to pollute water, he does not hold the rights to whether or not the upstream farmer may invest in new technology. Therefore, the downstream farmer has no bargaining power to get a hold of some of the additional profits earned by the upstream farmer. Similarly to the no-­‐liability scenario, this result is less obvious. In this case, the total net social welfare is still increased to $350, as opposed to $200. In effect, the downstream farmer still achieves the efficient outcome, eliminating pollution at the acre at which he values the right to pollute the most. The upstream farmer simply finds a cheaper way to achieve this outcome, and it benefits him greatly. Due to bargaining power, however, the upstream farmer keeps all of the benefits earned as a result of investing in technology as opposed to buying rights to pollute at the margin. The total benefits are $1250 ($900 in reduced damages for the downstream farmer plus $350 in profits for the upstream farmer), the same as in the no-­‐liability scenario after an investment in technology. In this case, however, after an investment in technology, the upstream farmer is much better off than he would have been after a bargain, resulting in a more equal distribution of wealth. As I have shown, efficiency will be achieved regardless of whether the downstream farmer or the upstream farmer starts with the property rights to pollution in the face of zero transaction costs. The resulting wealth distributions, indeed, will leave policymakers with something important to consider. -­‐43-­‐ This example essentially shows how the Coase Theorem operates in the case of two individuals using river water used for irrigation where one producer is harming the other. The Coase Theorem states that, with zero or negligible transaction costs, as in this example, regardless of where the initial property rights are placed, parties will bargain if it is profitable, and the same number of resources will be employed and produced (in other words, all resources will end up in the hands of their HVOs) and the total value of production will be the same and maximized. Efficient allocation of the property rights will be achieved. The only thing that will be different is the distribution of wealth. It can be seen that, in the liability scenario, both farmers make profits in the end, but the downstream farmer’s profits are maximized whereas the upstream farmers profits are reduced by having to pay for damages. In the no-­‐liability scenario, the upstream farmer’s profits are maximized while the downstream farmer’s profits are reduced either by absorbing the damages or by paying the upstream farmer to cultivate fewer acres. This is an extremely important point, and illuminates what I was explaining earlier about how your ultimate goals have a profound impact on what governance structures you choose. In a world devoid of transaction costs, when the pricing system is working smoothly, you can achieve efficiency no matter whom you endow with the initial property rights or in what direction you point the liability rule, but your choice will have an effect on the resulting distribution of wealth. There is one caveat to the Coase Theorem that must be pointed to at this time. I had said efficiency would be achieved no matter to whom the property -­‐44-­‐ right is initially endowed. This is not the case if preferences cannot be backed up by effective demand. Effective demand is the principle that value is not truly value unless it is backed up by actual money. For instance, I may tell you honestly that I would pay $500 to own an acre-­‐foot of water, but unless I actually have $500 to spend, this value is not considered effective demand. This reality plays out in an important way with regard to the Coase Theorem. To show this point, I will use the same polluting upstream farmer from the previous example, but in this case, his pollution hurts a recreational user downstream who enjoys swimming in the water. Imagine this recreational user is a resident who brings her child to go swimming in the river every weekend, and she values this activity at $500. If this resident initially is endowed with the property right to be free from pollution, the only way the upstream farmer can cultivate a crop is if he buys the property right from this resident. If the upstream farmer can only make a maximum profit of $400 producing on that tract of land, he will not be able to bargain successfully with the resident to acquire the right, and she will maintain the property right. The Coase Theorem says that, even if the property right is initially given to the upstream farmer, with zero or negligible transaction costs, the right should ultimately end up in the hands of the resident, because she is the highest-­‐valuing owner. And so it would happen if the resident had $500. If the upstream farmer has the right initially, he and the resident should be able to come to a mutually beneficial bargain where they are both made better off. The resident could pay the farmer, say, $450 to buy the right to pollute the water. The farmer will have made more than $400, and the resident will have $50 in -­‐45-­‐ surplus because she actually values the river at $500. The same total value of production results ($500) the property ends up in the hands of the HVO (the resident) and efficiency is achieved regardless of where the right was placed. But imagine, for a moment, that the resident does not actually have $500 but only $300. If she had the right, she would not sell it for less than $500. But if she does not have the right, all she can pay is $300. Then, if the property right is initially given to the farmer, he will keep it, and the total possible value will not be maximized, value here taken as utility. The farmer makes a $400 profit, and the $300 the resident actually has is not enough to convince him to stop cultivating. However, as defined by effective demand, the resident is only the HVO if she is initially endowed with the right. Thus, in the case that she is not endowed with the right, the farmer is the HVO, and the total value in ownership of the right is $400. If the resident is endowed with the right, she is the HVO of the right, valuing it at $500. The farmer will not be able to successfully bargain with her, and a greater maximum total value in ownership of the right is achieved at $500. As defined by effective demand, the HVO depends upon the initial endowment of the right(s) at question, and with whom the right ultimately ends up depends on where it starts. Thus, each initial endowment has its own efficient outcome. In this case, the efficient outcome is that right stays with its initial owner. That is not to say that one efficient outcome is not more “optimal” than the other, depending on your distributional goals, and depending on whether you are using effective demand or utility to define value. Clearly, $500 in value when the resident is endowed with the right is greater than $400 -­‐46-­‐ in value when the farmer is endowed with the right. The important point to remember is that, in situations where individuals cannot back up their preferences, the Coase Theorem fails to hold. Where the right ultimately ends up depends upon where it starts, even when there are no transaction costs. This realization spells trouble for anyone administering governance structures. In the case that the resident cannot back her value up with effective demand, if the goal is efficiency as determined by maximum utility, rather than maximum economic value, the resident should initially be endowed with the right. If the goal is efficiency as determined by maximum economic value, the right should be given to the farmer. This is not an easy question to answer, because utility is still value to the person who holds it. Utility is very difficult to measure, though, and if someone cannot back up their value with effective demand, one can never truly be certain if they are being honest about their valuation. It is much easier for an economist to substitute money for utility, and thus economic value for utility. Assuming one can effectively extract an individual’s true utility valuation of a property right, which is an extremely difficult task to undertake, then with whom you endow the initial property right is determined by what your goals are. Even in the case where the resident can back up her value with effective demand, if you have a distributional goal in mind that favors the farmer, you should give the right to the farmer. Then the farmer will have $450 in surplus and the resident $50 in surplus, as opposed to the entire surplus going to the resident. -­‐47-­‐ As interesting and useful as it clearly is to consider the Coase Theorem, in its world of zero or negligible transaction costs, it is still a reality that most real world bargaining situations involve significant transaction costs. I now turn to those cases that involve transaction costs, and I will show how the problem becomes more complex. And I will use a little help from my friends Calabresi and Melamed. Bargaining for Property Rights in a World Full of Transaction Costs Entitlements can be protected either by property rules or liability rules. The reader should have already gotten a taste for the two in the examples above. Property rights cannot be taken from their owner unless the owner sells them willingly at a price subjectively determined by the owner alone. Liability rules, on the other hand, effectively allow certain individuals to take property rights from other individuals with compensation. Whereas the compensation in the case of a strict property right is determined by the seller alone, the compensation in the case of a liability rule is determined by the state and is often given some objective standard of value, such as the market price. Indeed, this objective standard will often undervalue the property to the individual being stripped of it, given that some individuals would not be willing to sell their property at the market price. Usually there is significant social utility to be gained from such rules, and the state may or may not have sympathy for the victims of these takings, or care whether they are compensated for the costs they have borne. -­‐48-­‐ Property rights and liability rules are appropriate in different circumstances. It might be argued that simple property rights should govern everything, and that the market should determine which bargains and trades are made, and which are not. It would seem, after all, that efficiency could be achieved in this way; sellers will not sell their property unless such a deal makes them better off. This is the goal of efficiency, is it not? Indeed it is, but complications often arise; the real world comes calling, chock full of transaction costs, and deals that might otherwise be struck, making both parties better off, will be cast aside because these added costs burden the arrangement, making it unfruitful for one party or another. In such cases, liability rules may be more appropriate to achieve the maximum possible value. Calabresi and Melamed (1972) do a good job of detailing this point. Where they used a simple land example, I will substitute water examples. Take a simple example of two farmers, one upstream and one downstream. Imagine that the downstream farmer owns the rights to all the river flows. The decision, then, is whether or not to protect this right with a property or a liability rule. I will use unique numbers to make the example work smoothly. Say the downstream farmer is able to make a maximum of $1000 in profit by cultivating his land with the water that he owns. Say the upstream farmer, if he were able to get his hands on the water, could make a maximum of $1200 in profits by cultivating his land. According to the Coase Theorem, a bargain could be struck that would make both parties better off, granted that there are no transaction costs. For example, the upstream farmer could pay the -­‐49-­‐ downstream farmer $1100 for the rights to the water, making the downstream farmer $100 better off ($1100 -­‐ $1000) and the upstream farmer $100 better off ($1200 -­‐ $1100). The maximum value in ownership of the rights is achieved, that being $1200 ($1100 + $100), and the rights end up in the hands of their HVO, the upstream farmer. Thus, in order to achieve the efficient allocation of rights, this situation could be governed by a simple property rights rule. With property rights initially given to the downstream farmer, the upstream farmer, who is the HVO of the rights, could attain the rights through a bargain. Similarly, if the property rights are initially given to the upstream farmer, the downstream farmer cannot successfully bargain for the rights because he is not the HVO of the rights. Therefore, his benefits are $0, the upstream farmer’s benefits are $1200, and the maximum value in ownership of the rights is achieved, that being $1200. Once again, the difference in outcomes is in the resulting distribution of wealth. Whoever is initially given the property rights will be much wealthier even after successful bargaining. All this occurs seamlessly in a world without transaction costs. But let us enter the real world now, where there are almost certainly transaction costs to this bargain. Assume the downstream farmer is initially given the rights to the water flows. The upstream farmer must spend time and money accessing the downstream farmer, posing the bargain, determining with certainty how much he would value the rights, maintaining lines of communication until the deal is struck, possibly hiring lawyers or other third-­‐
-­‐50-­‐ party observers either to help legalize the deal or to moderate the bargain, completing paperwork, and estimating what the transaction costs will amount to prior to even beginning engagements. All of this could reasonably be quite costly. Imagine that the transaction costs total $300 for the upstream farmer. The deal will not be struck. The upstream farmer will have to compensate the downstream farmer for the $1000 in profits that the downstream farmer will be foregoing, as well as to pay $300 in transaction costs, totaling $1300 in all. This $1300 in costs is greater than the $1200 the upstream farmer would earn in profits. The upstream farmer would be losing $100 if he were to engage in this bargain, which he will not do. In order to achieve efficiency, this case cannot be governed by a simple property rule. It is irrelevant to consider the scenario in which the upstream farmer is initially given the rights to the water, because that is already the efficient allocation of the rights. Therefore, it is only relevant to consider the situation in which the lower-­‐valuing owner (LVO) is initially given the rights to the water. A liability rule, on the other hand, could work much more effectively. The downstream farmer starts with the right to all the water, but this time it is protected by a liability rule. A liability rule permits the upstream farmer to seize the property right from the downstream farmer if he pays the appropriate liability price to the downstream farmer. The appropriate liability price is usually determined to be the fair market price at which the downstream farmer could sell his rights voluntarily. Because the downstream farmer is made no worse off, and the upstream farmer is made better off, this is an efficient -­‐51-­‐ transaction, increasing the productive value of the water. The goal of the liability rule is to fully compensate the downstream farmer with the total profits the farmer could have made utilizing the water, thus completing a transaction involuntarily entered into by the downstream farmer that moves the rights from the LVO to the HVO. Any court or administrative body that employs a liability rule runs the risk of underestimating the full compensation value, thus undercompensating victims of takings. This would be undesirable from a distributional perspective, but it is still efficient if the upstream farmer is truly the HVO. Indeed, governance of transactions by a liability rule will also carry with it transaction costs of some sort. Different governance structures differ in their capabilities, and thus carry with them different transaction costs. Therefore, a liability rule will have different associated transaction costs than those associated with a strict property rights rule. If the facts of the case are easy enough to be determined by either an administrative board or a court, these transaction costs should be relatively low; lower than those associated with a market bargain, otherwise the liability rule is pointless. Moreover, because the upstream farmer is simply allowed to take the water at an objectively determined compensation value, this eradicates the costs of bargaining, and a lot of the time and money associated with such a market transaction. In this way, the liability rule can expedite the transaction of moving the rights from the LVO to the HVO. -­‐52-­‐ On the other hand, if there is conflict over what is objectively determined, the liability case may be taken to court for a full trial, which can be a wildly expensive and time-­‐consuming affair, maybe even more expensive than the transaction costs of bargaining. In this case, the transaction costs of bargaining, those being $300 for the upstream farmer, are already enough to deter a market bargain, which is why a liability rule would be considered in the first place. If the liability rule results in even greater transaction costs, there are a few other options to achieve the outcome of maximum value in ownership of the water rights, the efficient outcome. For one, the court could simply deny the appeal of the downstream farmer for a full trial and just implement the liability rule as they see fit. This would overcome some of the transaction costs of the trial and expedite the process of transferring the rights to the HVO. The downstream farmer could also just give in to the objective compensation value, equal to the fair market price for the water rights, instead of fighting for a better value. In this case, leaving the process to a simple property rule is not enough to ensure the efficient allocation of the water rights. A liability rule may be a good alternative that can decrease the transaction costs of transferring rights to the HVO, increasing the value in use of those rights. Water issues can get much more complicated, and interesting, partly because river water allocation does not typically involve only two individual farmers; it usually involves hundreds. I return, now, to the example that I used earlier of myself and ten other farmers along a river. Imagine a case where I want to buy the water rights of the ten other farmers through voluntary bargains -­‐53-­‐ because I know I could expand my production profitably. All of the water is necessary for the expansion I have in mind, without any of which my expansion would be fruitless. A property rule is enough to achieve the efficient allocation of the water rights in the event that transaction costs are low enough that my bargain with the ten farmers would still be mutually beneficial, but this is unlikely. With ten other individuals to bargain with, transaction costs could be pretty steep. There are all the usual costs of organizing and carrying out the negotiation, with holdout costs added on top. All ten farmers know that each one of them is essential for my expansion; I need the water of all ten farmers for it to work. Say my expansion will produce $2000 in profits for me, and that the water rights I will be taking from each of the ten farmers are worth only $100 in production for each of them. Say we all immediately determine that $125 is a fair price to pay for these rights. In a world without transaction costs, I would pay each farmer $125 for a total of $1250 and end up with $750 in surplus. Now, in a world of transaction costs, say the typical transaction costs add up to a total of $500. I will still come out on top with $250 in surplus. Here is where the holdout problem arises. Knowing his water right is essential for the transaction, each farmer has the incentive to hold out from the transaction to try to get his hands on some of the $250 of surplus I would end up with. If each farmer has this incentive, I then face the costs of convincing ten farmers that this transaction is worth it and that they should not hold out. In order to convince the holdouts to take the deal, perhaps I have to organize an open forum where everyone can discuss the deal, hold parties and dinners with -­‐54-­‐ cocktails to sweeten the other farmers to the deal, or raise the buying price to a level that is too sweet to cause a fuss over. On top of all the other transaction costs, these costs of convincing could be $500, amounting to a total of $2250 in transaction costs, resulting in a loss of $250 for me. I will, thus, forego this potentially productive transaction. In this case, a property right rule might not be the best governance structure. Instead, a liability rule could be implemented. Say the transaction costs of employing the liability rule are still $500, because we all have access to either a third-­‐party administrative body or court. The utility of the liability rule is that, if the case can be settled easily by the court or administrative body, with $500 in transaction costs, we can achieve the efficient outcome, succeeding where a property rule could not succeed. I still have to pay the farmers $1250 and pay transaction costs of $500 for a total of $1750, but this leaves me with $250 in surplus, the outcome I would have achieved had there not been holdouts with a property rule. It can be seen through this example that, given different circumstances, with different prevailing transaction costs, the appropriate governance structure changes. Therefore, in order to achieve the efficient allocation of water rights, one must consider the transaction costs associated with plausible governance structures and then choose the governance structure that most effectively achieves the efficient allocation of rights in a cost-­‐
minimizing way. Additionally, there will be a number of distributions of welfare produced as a consequence of implementing any governance structure, which -­‐55-­‐ are important to consider if distributional welfare is of importance to the policymaker. CONCLUSION Governing a resource is a very complex task, as has been seen in the case of water. Even then, I have only looked at a sliver of the possible situations under which water must be managed, namely river water for the purpose of agriculture. It seems that any decision regarding the governance structure presiding over water always has negative ramifications that must be weighed against the positive results. Different outcomes are laden with tradeoffs between goals, the desirability of which ultimately determines the course of action. Efficiency and distributional goals are not mutually exclusive, but they do often clash. The total value of production may be maximized across all farmers given a specific governance structure at the same time that a certain subset of farmers is injured by that governance structure. Distributional goals that cause greater equity may sacrifice potential efficiency gains, favoring the survival of every farming entity over increases in the total value of production. While this is generally a very important consideration in policy making, I will show through the exploration of the English common law of water rights, the California common law of water rights, and the California modern administrative law of water rights, that efficiency has often been the main goal, and the main outcome, of water policy. The law evolves with the prevailing transaction costs to permit the maximum value in use of water to be attained, the efficient outcome. -­‐56-­‐ The main lesson of this chapter is that transaction costs accompany every governance structure, and that they must be taken into account no matter which outcome is desired. The world of the Coase Theorem is certainly an ideal, one with zero or negligible transaction costs, that would be much simpler and faster in allocating property rights efficiently, but not one that is generally realistic. Transaction costs are prevalent and often numerous and significant, affecting what results can be produced by different governance structures. It is necessary that these transaction costs be considered when implementing a governance structure, because they ultimately affect whether and how one can achieve desirable outcomes. I hope to show this at greater length in the following three chapters: first, in Chapter 2, how transaction costs played a role in the English common law rulings over river water disputes, where some governance structures were more appropriate than others for the goal of efficiency, and how these entitlements changed as the pivotal unit of the transaction changed; then, in Chapter 3, how transactions costs played a role in the evolution of California common law of water, and, similarly, how certain governance structures were more appropriate than others as the conditions surrounding the transaction and its associated costs changed; and, finally, in Chapter 4, how the modern era of administrative water law in California came into being, and how that law still operates with regards to transaction costs. Two other points are central to this exploration. First, it will be seen that it is not just transaction costs that determine which governance structure is most appropriate to achieve efficiency. The economic conditions serving as a -­‐57-­‐ context for water use in different regions of the world are also paramount. Given the same transaction costs in England and in California, the types of uses that exist for water as well as the scarcity, or abundance, of that water are central to what governance structure is ultimately chosen. Second, and central to this thesis, is the idea that, not only are certain governance structures more appropriate for the prevailing transaction costs and economic conditions, but, additionally, policy makers and courts have, and should, actively transformed governance structures to conform with that which is most appropriate. This transformation will not necessarily be immediate, as there is institutional inertia to overcome, and people have to recognize changing conditions, which may take a while. But, ultimately, there is overwhelming evidence to suggest that both English and California courts and lawmakers adapted to changing transaction costs and economic conditions in order to match the times with the appropriate governance structure in order to achieve efficiency. -­‐58-­‐ Chapter 2 INTRODUCTION A good place to begin the story of water law is with English common law decisions dating from the sixteenth through the mid-­‐nineteenth centuries. There were two general rules by which English cases were decided for most of this era until industrialization and rapid growth began to change economic conditions in a powerful way. The first was the ancient use doctrine, and the second was the first occupancy doctrine. The ancient use doctrine protected anyone who claimed an “ancient use” of a waterway, typically twenty years or more, from anyone else along the same waterway who could conceivably be causing damages to the ancient user’s enjoyment or use of the waterway. It technically granted exclusive rights to the entire waterway, but in practice it was enforced a few miles upstream and downstream, a safe enough distance that any other user’s activities upstream or downstream would go unnoticed. When few users occupied the river, and water uses were not changing quickly, there were low transaction costs to bargaining along these rivers and it was likely that the ancient user was frequently the highest-­‐valuing owner (HVO) of the water rights. When uses were not changing quickly, and technology was advancing slowly, it was likely that those who were established along a waterway and had been -­‐59-­‐ employing the water for productive purposes for quite a while had already figured out the most productive use of the water, and were therefore the HVO of the rights to the water. These two conditions together made the ancient use doctrine appropriate for achieving efficiency. Newcomers could bargain easily or settle elsewhere. However, as uses began to change and more individuals began to occupy England’s rivers, it was no longer a good assumption that the ancient users were the HVOs. The courts gradually adopted the occupancy doctrine in place of the ancient use doctrine. The new doctrine protected the first individual to make an investment in a capital-­‐intensive use of the water from other users along the waterway. The new assumption was that investors in capital-­‐intensive uses of rivers were typically the HVOs of the water rights. The occupancy doctrine did nothing more than switch the initial placement of entitlements, but transaction costs were still low enough to induce efficient bargaining between the rights holder and the true HVO, in cases where the rights holder was not the HVO himself. The understanding of how rights structures like the ancient use doctrine and the occupancy doctrine emerged would be slightly augmented in practice by the common law’s treatment of water as something governed by rights from nature, in that water has and always will flow over and through the land naturally. Water not utilized for a specific purpose belonged to everyone and no one until appropriated by someone; a good was held in common by all of nature until it became held in use by an individual. This transformation in the -­‐60-­‐ understanding of where rights came from was a slow process, beginning in the seventeenth century and growing stronger in the eighteenth century. The rights from nature doctrine did little to change the practical functionality either of the ancient use or first occupancy rules, however, but understanding rights to water in this way set the stage for the eventual preeminence of the reasonable use doctrine that would emerge in the early nineteenth century. The reasonable use doctrine was substituted for the occupancy doctrine and granted all users along waterways “equal correlative rights” to the water. This meant that no longer did any one individual have the right to be free from all damages, but rather minimal damages inherent in the shared use of the waterway were permitted in order to increase the number of users of the water. All users shared an equal right to the water, and while large damages could be litigated, minimal injury resulting from basic use of the river were to be ignored, “where injury constituted deprivation of one’s ‘due proportion’ of the benefit from the waterway” (Kanazawa, p. 164). “Due proportion” of benefit was generally understood to be proportional to one’s riparian landownership; the more riparian land one owned, the more water one was entitled to. Transitioning into this rule allowed a much greater number of users to occupy England’s waterways and, as will be seen, to increase the productivity value in use of that water, therefore achieving the efficient allocation of rights to water when the previous two rules would have failed. All three of these rules will be expanded upon in the coming pages, and it will be shown that it made good -­‐61-­‐ economic sense to employ these rules differentially under differing economic conditions and transaction costs. English common law courts did more than just provide inspiration for subsequent rulings in the United States. The evolution of rules governing water in the English courts demonstrated quite clearly how governance structures can and should evolve with changing economic conditions and transaction cost environments. Given a specific set of transaction costs and particular underlying economic conditions, some rules are more appropriate than others to achieve a specific set of goals. As will be seen, the adoption of prior appropriation or first occupancy as the governing doctrine over the original ancient use doctrine made little practical difference in whether or not efficiency was achieved because actors were still operating in a low transaction cost world. All that this switch accomplished was to place the rights initially into the hands of the newly perceived highest-­‐valuing owners (HVOs) of the water. The only thing that would have changed is the distribution of wealth between the new rights holders of the water and the ancient users. It seems the courts valued the social benefit of this move, in recognizing first investors in capital as the HVOs, over the moral dilemma of a new wealth distribution, which robbed ancient users of their use or enjoyment of a waterway if they had not been the first occupants. However, with industrialization and a growing demand for watercourses in the early nineteenth century, the nature of transactions with regard to water began to change rapidly, and the adoption of the reasonable use doctrine was, suitably so, the most reasonable decision to make in order to achieve the -­‐62-­‐ efficient allocation of property rights, either through initial placements of rights or the facilitation of voluntary exchange. Transaction costs began to increase, looking more like those existing in our complex, contemporary world, and were enough of a burden to bargains that the rule of reasonable use was the most appropriate for maximizing total value of use. While transaction costs are truly the focal point of this analysis of the English common law, I will point out that the way the resource is used also influences the appropriateness of various rules, and use this as a transition into a discussion of the history of California water law within the context of US water law more generally. GOVERNANCE THROUGH THE ANCIENT USE DOCTRINE A Brief Discussion of the Relevant Conditions Before industrialization, uses along rivers and streams were not very water intensive. They consisted of various milling activities that included grinding grain, fulling wool, and mining, among others, all generally simple processes that did not create massive demand for water. Mercantilism was on the rise in the sixteenth century and trade was growing, with important products imported and exported to and from the New World, Africa, and Asia. Still, the full effects of a mature industrial transition would not be seen until later into the eighteenth and nineteenth centuries, when new sources of massive power generation came on the scene. As a result, in the sixteenth and seventeenth centuries, production primarily took place on a small-­‐scale, without intense production processes that required a lot of space and resources. This meant that there was not yet a great number of enterprising individuals vying for access to rivers and streams, and -­‐63-­‐ those that were utilizing flows did not require great volumes of water. Mills, while they could disrupt flows for users downstream, did not do so in a very significant way, in that damages to other users were small. Perhaps more importantly, with the result of keeping transaction costs low, damages were not likely to accrue in a significant way to more than one party. Most conflicts were one-­‐on-­‐one disputes that did not involve other parties, given the relatively sparse dotting of the rivers with mills, and the generally undisruptive nature of the mills that existed, removing the necessity to bargain with many parties. For instance, one farmer who claimed an ancient use might seek to defend that ancient use from one user upstream that was diverting the river slightly for the purpose of a fulling mill. Or there might have been a downstream user who created a dam for a grinding mill that flooded the lands of an upstream ancient user. Unlike diversions for agricultural irrigation, mills did not consume the water they used, in that most of the water that was utilized by mills returned to the river or stream from which it came. In contrast, the majority of water for irrigation is consumed, either by the crops themselves or by the processes of evaporation and evapotranspiration. While there can be some return flows, either as surface runoff or by percolation through the soil and along groundwater avenues back into the river or stream flow, most of the water does used for irrigation not return to its source. Even then, farmers did not present notable competition for river water because rainfall was abundant across England, meaning that river diversions for irrigation were either unnecessary or necessary only in sparse amounts -­‐64-­‐ infrequently. In fact, looking at historical rainfall data from England relative to California, average annual rainfall, as well as average rainfall during the growing season, is always much greater in England than in California. Average rainfall in California is around twenty-­‐four inches (“UK: Climate Period”), while average rainfall in England is about forty-­‐five inches (“California: Monthly Average Precipitation”). Moreover, the low-­‐precipitation regions of England receive about as much rainfall as the average in California whereas the low-­‐precipitation areas of California, which are expansive, receive less than five inches per year (“California: Precipitation”; “Rainfall Amount Annual Average 1971-­‐2000”). This makes rainfall more consistently uniform across the whole country of England. Given low demand for water, it might seem that this resource could be governed by a free-­‐access doctrine of “anything goes.” After all, it would be rare that competing users would actually come into conflict. Water was plentiful, and water users were not heavy consumers of the water, leaving flows generally intact in their natural state, free to be used by the next riparian landowner downstream. Any rule that was instituted would have little practical consequence for the majority of the users of both rivers and streams, except, perhaps, for distributional welfare, which might have been important to particular cases, and in general for keeping the peace. That being said, it was necessary to have some rule in place to govern those periodic situations in which there was conflict. Despite the fact that most cases involved one-­‐on-­‐one conflicts between adjacent riparian landowners, setting the stage for a low transaction cost scenario, without an initial placement of rights there was nothing stopping -­‐65-­‐ any party from producing harm to the other party for their own private benefit. Indeed, because transaction costs were low, harmed parties could engage in private bargains for rights appurtenant to water use upstream or downstream, even without a strict governance structure. Much like the no-­‐liability scenario discussed in Chapter 1, the efficient allocation of rights could still be achieved given low transaction costs. If a dam downstream flooded a riparian landowner’s land upstream, but the upstream owner was the HVO, he could bargain with the dam owner to achieve an efficient outcome. But if watercourses lacked a governing system of rights, one that initially placed rights and enforced fair bargains in them, there would be no consistent administration of justice. Without defensible property rights, there would be less incentive for, and more risk involved in, future investments in capital, labor, and innovation due to the uncertainty of obtaining profits from such ventures. The starting point of no governance structure would carry risk that would apply to both potential victims of damages as well as ventures causing the damage. If, given this starting point, at any time a governance structure might be instituted granting water rights to the class of mill owners most often the victim of damages, there would be less incentive for entrepreneurs that might produce that damage to engage in productive activity. For instance, as a shepherd and wool fuller in the absence of any type of water rights, I might seek to establish a mill along a stream to begin production. In contrast, simply instituting an initial placement of rights would facilitate efficient bargains for rights to use water that entrepreneurs were fearful to invest in given an initial lack of defensible rights. -­‐66-­‐ Thus, given an initial lack of any governance structure, the risk of an unfavorable placement of rights by the government any time after one invests in uses of a waterway might deter one from pursuing productive activities for fear of losing one’s wealth to an unfavorable placement of rights. This would be harmful to the potential increases in productive value of the water that new uses bring. Better to always place initial rights than to subject a precious resource like water to no governance structure at all. Additionally, a system of law that simply turned its head when competing users came into conflict over a resource might lose credibility. Lacking a strict governance structure for those few times when conflicts did arise might have caused greater harm than good in the long run, even if bargaining was still theoretically possible. In England, a strict governance structure was ultimately used to govern watercourses, for these and other reasons to be discussed. The governance structure that common law courts employed placed initial water rights, as I have argued is much better than the no-­‐governance alternative, protecting some users against others and setting the stage for consistent adjudication of rights and predictable bargaining outcomes that would achieve the efficient allocation of water rights. What the Ancient Use Doctrine Is and How It Can Be Applied The early English common law courts governed watercourses through the rule of ancient use. This rule protected those users along the stream that had been established since “time immemorial,” which usually meant a period of twenty years or more. These ancient users were granted the right to an unimpeded -­‐67-­‐ stream flow. Anyone wanting to gain access to the stream would either have to buy out these ancient users, or they might be brought to court and made to pay damages for infringing upon the rights of the ancient users. The most common cases brought to court involved disagreements or arguments between adjacent mill owners. Sometimes, a downstream mill owner would tear down the mill of an upstream mill owner if they believed the upstream mill impeded flows to their mill unjustly, in which case the upstream mill owner would bring the downstream owner to court for causing this harm. While tearing down another person’s property was illegal, the resulting suits pertained to the water right at question, that of an unimpeded stream flow, and who owned it, not the action of tearing down a mill. Other times, a plaintiff would bring a suit against a defendant who had diverted a large portion of a stream to flow to his mill off the river, radically reducing the stream flow in a way not typical of most mills. The plaintiff would generally claim that he or she held the right to ancient use, and thus to unimpeded stream flows, and would seek to defend that against the actions of the defendant which the plaintiff saw as a threat. For instance, if I believed I held the right of ancient use, and you came along and diverted a large portion of the stream flow upstream from my land, I might take you to court to defend my ancient use right and try to legally restrict you from that action. Still another example is that of a plaintiff who might argue that, by tearing down his old mills and rebuilding new ones in their place, the defendant, the obvious holder of the ancient use right initially, had lost his ancient right to the stream flow through this action. The plaintiff might claim that the defendant had -­‐68-­‐ altered the nature of his use and that, as a result, the use and the right was no longer ancient. Cases just like these will be elaborated below to demonstrate the decisions and the principles they upheld. All of these cases have one thing in common: they existed within the context of a low transaction cost environment. Parties to a suit generally lived close to one another, suits were bilateral conflicts that did not significantly affect any others settled along the same waterway, the facts of the cases were relatively clear and simple, and the adjudication of rights was generally obvious and straightforward. For efficiency’s sake, it did not matter where the initial rights to water flows, and the rights to alter these flows, were placed. Because of a lack of significant transaction costs, bargaining could move most water rights to the HVOs, achieving the efficient allocation of rights most of the time. In the case that bargaining was not possible, though, there were a few other good reasons why the ancient use doctrine was appropriate for efficiency purposes at this time, which will be elaborated below. Further, such a rule encouraged a distribution that was likely favorable given that ancient users were often landlords whose high social status brought them power and influence. Russell v. Handford: An Illustrative Case Russell v. Handford, decided in 1583 (Russell v. Handford, 74 ER 248), is a case representative of the ancient use doctrine that prevailed at the time. Handford, the defendant, had built a mill just upstream from Russell, the plaintiff, and had begun to divert stream water to his own mill. Russell was a lord of the town, and the residents of the town had used his mill for grinding since “time immemorial,” -­‐69-­‐ granting Russell the ancient use right. With the erection of Handford’s mill upstream, Russell complained of decreased flows to his mill, pleading that his mill was an ancient one, and that he had the right to unimpeded flows. The court ruled in the favor of Russell. As I explained above, this ruling is sufficient for efficiency purposes because of low transaction costs. The ancient use right was obviously in the hands of Russell and, given low transaction costs, Handford could have bargained for the right to the water if he was the HVO. The placement of the right in the hands of Russell allowed both of these parties, as well as other parties in the wake of this case, to assume that the ancient use protection prevails, encouraging parties to bargain thereafter if beneficial. Even after Handford was made to pay damages, he could still bargain with Russell if it were beneficial. Private contracting between these two would have been easy enough. After all, Handford was one of Russell’s tenants and neighbors, and communication between them would likely not have been hampered. If Handford somehow was capable of reaching a new consumer base, swinging some or most of Russell’s consumer base over to his own mill, or innovating a new milling technique or technology that was cheaper or more productive, and could turn a profit through the use of his mill in any of these ways, then he could reasonably bargain with Russell if his profits were greater than what Russell would lose as a result. A mutually beneficial bargain, then, would be possible. In such circumstances, the existence of the ancient use doctrine merely delineated the initial rights to the water and let the parties to the transaction bargain under a scenario of low transaction costs. -­‐70-­‐ In cases where the transaction costs to bargaining might have been too high – either due to unforeseen complications, complex procedures, recalcitrance on the part of either party, extortion, etc. – the ancient use doctrine also seems reasonable given the characteristics of the time period. The use of water, and the nature of mill production, was not changing rapidly, if at all. The decision to employ the ancient use doctrine, then, could have been encouraged by the belief that whoever was utilizing river flows must have figured out the most productive way to employ this natural resource a while ago. Thus, in cases of significant transaction costs to bargaining, where a productive bargain might be impossible, the ancient use doctrine would already ensure efficiency by keeping the right to water in the hands of the presumed HVO of the water. For example, imagine a different governance structure that did not protect the ancient user downstream. An upstream user, granted the right to the water instead, might increase upstream diversions beyond that which was in fact necessary for this user for the sole purpose of extracting payments from the downstream user in exchange for a decrease in diversion activities. Without the right to the water, the ancient user would have to bargain to gain access to the water and to achieve the efficient result, a reasonable outcome. But, although such instances might have been infrequent, in the face of significant transaction costs the ancient user might have been deterred from a bargain. Under the assumption that the ancient user, in general, was the HVO, the ancient use doctrine helped to preserve efficiency. -­‐71-­‐ Efficiency was achieved in another way by the ancient use doctrine. If the most ancient, longest-­‐established users thought that, at any moment they could be stripped of their ancient use of the water, they might hesitate from investing in new and improved technology or production processes. If another user came along and was granted the right to divert the water in a way that damaged an adjacent ancient user, there is certainly the possibility that this new user was employing the water in the most productive way possible, in which case efficiency could be achieved through bargaining. But the assumption during this time period may have been that the ancient users, on aggregate, were already employing the most productive technology and production processes. Under this assumption, courts may have faced the risk that newly established users might not have attained maximum productivity, in which case, under certain scenarios of high transaction costs, bargaining with the more productive ancient user might not have occurred, and efficiency gains would have been lost. Another reason the ancient use doctrine makes sense is that water was plentiful, not scarce, and it was not too difficult an endeavor to find a place to establish a mill where no one had established previously. Indeed, the number of water cases tried during this time period was not great (Rose, p. 269), suggesting that conflict was not a common occurrence, and that it was either easy enough to bargain or to move to a more undeveloped stream or river. The establishment of the ancient use doctrine sent a signal to newcomers that if they could not turn enough of a profit to justify a bargain with an established ancient user, they should find another place to settle. Ancient users were protected on the -­‐72-­‐ assumption that they were the HVOs, and newcomers were forced to haggle or go away. An important consideration is the possibility of cases in which one party to a potential bargain cut off negotiations because of an aversion to the buying and selling of land and rights appurtenant to land ownership, such as the right to water. Rather than a transaction cost, this can be seen as a source of value for the party averse to negotiations. Historically, land signified power and prestige, and was often owned by lords with seigneurial control over townships. In a sense, landownership and social and cultural power were one and the same. “In traditional Europe, the mass of the population derived its wealth and social status from the land” (Mendels, p. 242). Certainly, the attachment to land ownership and associated water rights might have presented a strong enough resistance to the marketing of land to hinder potentially beneficial bargains. This attachment to the land, and to the way things were, had always been, and “ought to be” could have given land owners utility in maintaining the status quo. If the value of their utility was truly large enough to outweigh the gains from bargaining with newly productive users, it may or may not have been in the interest of courts to disrupt the status quo, depending on which distribution of wealth they favored. If the landowner who placed significant utility value in maintaining the status quo was the same person as the ancient user, and under the assumption that the ancient user was generally also the HVO in terms of production value, then it was definitely in the interest of efficiency to enforce the ancient use -­‐73-­‐ doctrine. If the ancient user was not the HVO in this case, but rather the newly established user was, under the assumption of low transaction costs these parties would be welcome to bargain. But, remember, the ancient user might be averse to buying and selling these types of rights. In the case that his utility valuation of maintaining the status quo is so high so as to outweigh the increased value of production from the new user, a court would have to decide whether they value increased production value or the ancient user’s utility more. Protecting the ancient user would be efficient, but it would grant one individual a lot of utility through the maintenance of the status quo, a concept that is not necessarily productive in the long run, to the detriment of many other individuals who could each benefit from the production of the newly established user. Depending on the court’s decision, a different distribution of wealth would be achieved, favoring either the ancient user or the new user. The increase in value through the new user would come in the form of actual production value, backed by effective demand, while the value maintained in the ancient user would merely be utility, not a value backed up by effective demand through production. This is a case where economists would argue over whether utility or effective demand should be used to determine efficiency outcomes, not an easy determination to make. If the newly established user started with the right to the water, but the ancient user would actually gain more utility from the right, despite a lack of effective demand, the greatest value from the right would be derived in the hands of the ancient user. With the right in his hands, he would be -­‐74-­‐ the HVO. However, in terms of economic value, with the right in the hands of the first occupant, the ancient user would not be the HVO. This distinction is important in that the first occupancy doctrine reflected an attitude in the courts that there was greater social value in the production of economic value rather than utility value in the hands of ancient users who would rather stall economic growth. This final distinction is important for cases where the Coase Theorem may fail due to a lack of effective demand. For instance, if a court valued utility over economic value of production as the marker for efficiency in this last case, efficiency would be best achieved by maintaining the ancient use doctrine. But if economic value, as defined monetarily, were valued more than utility, in the case that the ancient user lacks effective demand to back up his utility valuation of maintaining the status quo, then it would be best to place the rights in the hands of the new user, so as to maximize production value, given in this case that the new user is the HVO. All in all, though, the courts probably made the right decision, for the sake of total value of production as well as utility, to leave the rights in the hands of the ancient users, assuming that, on average, ancient users were already employing capital and labor in a profit-­‐maximizing way, and also that transaction costs were low. After all, conflict almost always arose between adjacent riparian landowners with few costs to bargaining, and the damaging effects of actions on the part of either party was rarely so significant that it would involve more than just two parties, which also kept transaction costs to a -­‐75-­‐ minimum. Further, this decision served the distributional goal of not hurting pre-­‐established users, and helped to maintain the status quo. Luttrel’s Case: Another Illustrative Case Luttrel’s Case, decided in 1601 (Luttrel’s Case, 76 ER 1065), is another good example of how the early ancient use doctrine operated. Edward Cottel brought a case against Luttrel and two companions. Cottel had torn down two fulling mills that used to utilize river water adjacent to his land and, in their place, had built two new corn grinding mills because the fulling mills were old and ruinous; the mills were no longer productive. Luttrel and his companions, once the fulling mills were replaced by grinding mills, tore down a thick bank that formed a small canal operating to redirect the river to the two mills Cottel had recently finished. When Cottel brought Luttrel to court, Luttrel claimed that, by changing the nature of the mills, Cottel had lost his right to the watercourse because the ancient use right attached only to the original fulling mills. Seeking to protect his ancient use right, Cottel pleaded that both the river and the canal had run “time out of mind,” and that he had used these mills time out of mind, regardless of whether they were for fulling or grinding; he was pleading an ancient flow and use of the water. The court held in favor of Cottel, claiming that his ancient right was not lost with the erection of two new mills. The watercourse was an ancient one that ran to Cottel’s mills generally. The purpose of his mills, or the type of mills Cottel owned, did not affect the validity of his right. Thus, his ancient use was protected and Luttrel was made to pay damages. -­‐76-­‐ This case can be understood in the same way that Russell v. Handford was understood. By delineating and protecting one set of entitlements, the courts opened the door for productive bargaining to take place between the two parties under a low transaction cost scenario. If Cottel was the HVO, then bargaining would not occur and the right to the water would remain in the hands of the perceived and the actual HVO, which, in this case, was Cottel, the ancient user. Given the generally slow pace of economic development, and the significant amount of time and effort involved in altering production processes, such as Cottel’s rebuilding his two mills for a different purpose, it seems most socially beneficial that the English courts would adopt the ancient use doctrine, ensuring that the ancient user’s investments and innovations would be defended. Another way to consider the problem is by accounting for the fact that ancient users, given the abundance of water, the general ease of bargaining with adjacent riparian landowners, and the abundance of open mill sites along England’s rivers and streams, might not take precautions against potentially disruptive neighbors or external parties (Rose, p. 270). The ancient use doctrine was a way of telling potential competition, again, to bargain or pack up, both options assumed to be viable alternatives. By setting the ancient use precedent, the courts were sending the message that damages to established users would not be tolerated unless a bargain took place. If a newcomer were the HVO, low transaction costs would permit bargains. If the newcomer were not the HVO, they would not be able to bargain, but there were plenty of other sites along England’s waterways for ambitious entrepreneurs to establish a mill or dam site. Lastly, there are -­‐77-­‐ certainly spots along rivers that are better suited as mill sites, either because water flow is greater, or the topography lends itself to mill construction; in other words, not all mill sites are created equally. For a newcomer to take this spot from an established user, they could, once again, bargain for the right to access the productive spot, or bargain to buy the ancient user’s land. This is, in fact, a strong case for the ancient use doctrine, because it was even more likely that the ancient user had already been employing the watercourse in the most productive way. Sury v. Pigot: Doctrinal Shifts In Sury v. Pigot in 1625 (Sury v. Pigot, 79 ER 1263), the court deciding the case made a significant claim about the law of nature, or rights from nature, as I will refer to them so as not to confuse them with Lockean natural rights. This began to slowly alter the way water cases were decided, representing somewhat of a transition between primary employment of the ancient use doctrine to primary employment of first occupancy or prior appropriation. As stated earlier, this attachment of rights from nature to water cases did not make much practical difference in deciding cases, but it represented a slow and important doctrinal shift. Sury brought Pigot and three other defendants to court for stopping a watercourse that carried water to his property. Sury had been diverting water from a stream in order to fill up a pond on his land at which his cattle and the cattle owned by a few other individuals had been watering. Upstream, Pigot built a dam that diverted significant flows from the stream, causing damages to Sury’s pond and the watering of his cattle. Pigot claimed that Sury’s ancient right to the -­‐78-­‐ watercourse had vanished recently when another landowner had bought the respective, separate lands of both Pigot and Sury and united them under common possession. He believed that the ancient use doctrine did not apply because it only held when Sury owned his land separate from Pigot, but that the combination of their two properties erased the water right. The court held in favor of Sury, claiming that the ancient use right did not disappear under common possession. But they added an interesting twist to their decision that reflected a doctrine of right from nature that was growing in influence. Justice Whitlock claimed that “there needs no prescription or custom in this case, for water hath its natural course…. [T]he watercourse doth not begin by the consent of the parties, nor by prescription, but ex jurae naturae, and therefore shall not be extinguished by unity” (Getzler, p. 131). Ex jurae naturae would come to be a heavily cited phrase, representing the new belief that water was truly a natural right legally separate from the nature of the surrounding landownership, and that once attained by a riparian landowner, the unity of possession of land seen in Sury v. Pigot did not affect this right from nature. While the right from nature was not congruent with the ancient use right, the ancient user was essentially the owner of the right to water from nature because he was the first to access this right. Rather than specifically being attached to the riparian land owned by the ancient user, the right to water from nature was attached to the ancient user, himself, that was the first to access this right. Another significant detail about how some decisions over water cases were phrased changed: this court claimed that one no longer had to plead that -­‐79-­‐ one’s specific use of the water was ancient, only that the water that flowed past one’s land was an ancient flow. This was important because it essentially nullified the ancient use doctrine, substituting for it an ancient flow doctrine. In this sense, someone who had only established their use a year prior to the case could plead the existence of an ancient flow and have their use protected. This effectively transformed the ancient use doctrine into a prior use doctrine, although it was still centered on the ancientness of the water. The water flow itself simply had to be an ancient water flow, and to earn a right to this water you simply had to be the prior user, the one who accessed the ancient flow first. This doctrinally began to shift the courts away from ancient use, although it made little practical difference at first because the ancient users were still the prior users. Still, there were a growing number of users that were “prior” users but could not establish an ancient right because they had not been around for twenty or more years, a long period of time in a country that, slowly but surely, was approaching rapid economic growth. The courts surely began to recognize this trend, and decided that too many users would be left unprotected from damaging neighbors simply because they had not been established for twenty years. This might discourage future investment, in that a potential investor might forego establishing along a waterway if his investment had no way of being protected under the ancient use or flow doctrine. As merely a prior user, but not yet an ancient user, this user would have faced uncertain danger of incurring damages from a subsequent user and having no legal recourse to protect his investments, given that neither user was an ancient user. -­‐80-­‐ Additionally, given that the nature of water use was not yet changing rapidly, the prior user of only one year was essentially the same entity as an ancient user, and was probably the HVO. In the same way that ancient users had probably figured out the best way to maximize production value in use of a waterway, a newly established prior user, settling along a stretch of water devoid of ancient users, probably also had the means to maximize the value in use along their stretch of river. The prior use doctrine would protect these prior users in the same way that ancient users were protected, under the assumption that they were the HVOs. This was still a good assumption because, just like the ancient users, prior users would have been capable of implementing the best technology and production processes of the time period, which did not change rapidly or require new skills that took significant extra education to acquire. And even if one of these prior users was not the HVO, transaction costs were low enough that simply placing these initial entitlements allowed for bargaining to occur. The hazy transformation of the ancient use doctrine into the ancient flow doctrine, which was really a prior use doctrine, which was also influenced by a law of rights from nature, was slow and not wildly influential. Even though this case was decided in 1625, the original ancient use doctrine would be utilized periodically for at least another hundred years, all its various forms and iterations being used at times. Moreover, other than reflecting a slow doctrinal shift, one that would later become important for efficiency, this transformation, in the short run, was not all that important for efficiency. Through the rest of the -­‐81-­‐ seventeenth century and into the early eighteenth century, transaction costs along England’s waterways were still low. No matter where the initial rights were placed, a productive bargain could occur. The rights from nature doctrine, too, was not a cut-­‐and-­‐dried rule with only one form. It could be used to mean that “the water had always flowed past the owner’s land, or because the water had customarily been an incident of value to that land, or was a necessary incident to the enjoyment of the land” (Getzler, p. 131). It is possible that these three doctrines, the ancient use, the ancient flow or prior use, and the rights from nature, all in their various forms, were not reduced to one, simple rule because some of them were more appropriate in different cases than were the other iterations of the rule. It is also possible that, due to slow communication and transportation, or geographic differences in rulings, one coherent rule never could quite coalesce properly because some variations truly were more appropriate for certain regions than other regions. It is also possible that judges simply did not care all too much to make one coherent rule because any of these forms worked well for efficiency at different times and because water cases were few to begin with (Rose, p. 268). Given a paucity of cases, and a low transaction cost environment, it must have been clear that, no matter where the initial rights were placed, parties were welcome to bargain. If they could not bargain, the newcomer could leave and settle elsewhere. The several variants of the basic rule were of no special consequence, other than, perhaps, to favor some distribution to satisfy the judge’s moral appeal. -­‐82-­‐ There are many more cases that illustrate these ancient use and natural rights concepts that were deployed primarily in the sixteenth and seventeenth centuries.1 These are only a handful among a number of cases that all portray the ancient use and natural rights doctrines in very similar ways to the three cases elaborated above. In the mid-­‐eighteenth century, though, along came William Blackstone, whose doctrine of first occupancy, or of prior appropriation, as it also came to be known, became the leading rule in water cases. It was somewhat of a spinoff of the natural rights doctrine, and changed which parties the courts favored, eliminating the ancient use and ancient flow doctrines and replacing them with something new. This new rule, like the rules that came before it, was also appropriate in light of the relevant transaction costs and the prevailing economic conditions, but it placed the rights to water in new hands. GOVERNANCE THROUGH THE FIRST OCCUPANCY DOCTRINE The Influence of Economic Growth and William Blackstone The eighteenth century brought proto-­‐industrialization, the early stages of industrialization, to England. This involved greater commercialization of agricultural production, the acquisition of surplus labor for early industrial purposes, and greater demand for manufactured goods and thus greater supply of goods that required larger power sources and new and improved manufacturing technologies (Mendels, p. 244-­‐47). Demand for water was still 1 For reference, see these, among others: Moore vs. Brown, 73 ER 723 (1572); Sands v. Trefuses, 79 ER 1094 (1639); Countess of Rutland v. Bowler, 81 ER 1087 (1622); William Aldred’s Case, 77 ER 816 (1610), which was not about water but concerned the creation and use of a natural rights doctrine, within which an analogy was made to water; and Smith v. Babb, 74 ER 815 (1588). -­‐83-­‐ not overwhelming; water had not yet become a scarce resource. That being said, with greater economic growth, an increased pace in the transformation of production processes and technology, and increased innovation characteristic of the Enlightenment period, the presumption that the ancient user was the HVO was no longer as valid. Newcomers could bring new technologies and production processes to rivers, ones that might change every decade or so whereas simpler, antecedent technologies like linen looms used to last and remain relevant for sixty years (Mendels, p. 243). New economic developments were rapidly increasing the potential for productive value in use of watercourses. Many individuals “developed their commercial agriculture to supply the needed food surpluses” (Mendels, p. 255), which freed up labor and supported growing urbanization, industrialization, and the machine industry. Given that newcomers might have then been the HVOs of water rights more often would soon necessitate a change in doctrine. The ancient use doctrine, as will be seen, was no longer appropriate as more and more entrepreneurs established mills to utilize waterpower for factories and other aspects of the rising machine industry (Tvedt, p. 40). William Blackstone, a judge and political philosopher, published Commentaries on the Law of England (1765-­‐1769), which contemplated the source of law afresh, using natural rights shared in common by all as a point of departure. These natural rights are reminiscent of the rights from nature doctrine that I have been discussing, but they are slightly different and have different consequences. Blackstone’s new philosophy of rights supported the -­‐84-­‐ notion that the ancient user could no longer be assumed to be the HVO, and that a new rule was necessary to maximize the value in use of England’s waterways. In the state of nature, according to Blackstone, “the all-­‐bountiful creator gave to man ‘dominion over all the earth…’. This is the only true and solid foundation of man’s dominion over external things” and “that all was in common among them” (Blackstone, 3); in other words, everything was owned in common by all men. Therefore, an individual owned property only when it is was in his hands and he was putting it to use; when it left his hands and he dropped his use, however, the right to a resource vanished. This was detrimental to anyone looking to invest time and effort into maintaining and improving upon property, because there was nothing stopping someone else from stealing their benefits. “But when mankind increased in number, craft, and ambition, it became necessary to entertain conceptions of a more permanent dominion” (Blackstone, 3) for few items of property “could be fit for use, till improved and meliorated by the bodily labour of the occupant: which bodily labour…is universally allowed to give the fairest and most reasonable title to an exclusive property therein” (Blackstone, 5). In other words, it became necessary for users to hold a private right to articles of property in order that their investments in capital and labor in this property would be protected and recognized. It was necessary for society to endow certain individuals with stable property rights in order to overcome problems associated with the commons, most notably the tragedy of the commons, in which investments in time, labor, and capital would not be protected from the -­‐85-­‐ mischief of others, and would deter innovation and economic growth. Moreover, with growing populations and ambitions, there would too high of a person-­‐to-­‐
resource ratio for common ownership to work smoothly, because so many individuals would want access to the same resource, and would likely destroy that resource instead of cultivating it. The defining characteristic of any use-­‐rights in property, for Blackstone, was occupation of that property. Whoever was the first to occupy, or properly appropriate, a given property from the commons owned initially by all earned individual rights to use to that property that were then protected. Hence, the occupancy doctrine for water, which grew out of this understanding of rights: the first person to newly invest in capital expenditure to utilize a water resource gained rights as the first occupant, protected from subsequent upstream and downstream improvers or non-­‐improvers. This was slightly different from that which governed more tangible property rights, because Blackstone saw water as a transient property, one to which no man could ever gain a completely private right. As a result, water rights in use would “still belong to the first occupant, during the time he holds possession of them, and no longer” (Blackstone, 14). In other words, much like in a natural state of the world, where all resources were held in common, any individual had a right to water only so long as he was using it, and lost that right through non-­‐use. This was the defining characteristic of the occupancy doctrine. -­‐86-­‐ How First Occupancy Differed from the Ancient Use Doctrine To be clear, this doctrine differed from the ancient use doctrine in three important ways. First, the ancient user was no longer presumed to be the HVO. It was assumed that the first person to invest capital was the HVO. This law protected and encouraged new development and growth, which was, as subsequent cases below will further evidence, the most appropriate rule for achieving efficiency. Second, whereas the ancient use doctrine protected uses of the river that were just for pleasure as opposed to production, the occupancy doctrine no longer did. This difference is fundamental: downstream recreational users that were previously protected by ancient use were no longer protected, and a capital owner upstream would now earn the right to the water if they were the first to make an investment. Third, whereas the ancient use doctrine gave the ancient user the right to a wholly unimpeded flow, if that is what he or she desired, under the occupancy doctrine, that first occupant only earned the right to what they were productively appropriating. Flows that the first occupant did not appropriate for a productive use could be appropriated by others along the stream. This opened up the river to a greater number of users, which would have the effect of increasing the productive value in use of England’s waters. No longer was the initial water rights owner the unique owner of any given stretch of water upon which he was a first occupant, granted the power to deter all others from settling nearby. Instead, there would be many first occupants along a given stretch of river, so long as the river flows could be productively divided up among the competing uses. -­‐87-­‐ Lastly, if anyone protected by first occupancy stopped appropriating their flows for a protracted period of time, a competing user could sneak in and claim the rights for himself in the event that the first occupant had been sleeping on his rights. Given that water power was essential for all major aspects of industrial production, it was unproductive for a first occupant to shut down production for long periods of time and maintain the first occupancy right. It made more sense to allow a new user to establish a right in their place, so that, in the initial user’s prolonged absence, the new user could become a first occupant and use the waterway productively. Bealey v. Shaw: An Illustrative Case The courts adopted the occupancy doctrine wholeheartedly in Bealey v. Shaw, decided in 1805 (Bealey v. Shaw, 102 ER 1266). Shaw’s predecessors had built mills in 1724 along a river, enlarged them around 1770 and again in 1791. Each improvement resulted in greater diversion of the stream water. Bealey built a mill in 1781 downstream from Shaw’s predecessors, in between Shaw’s predecessors’ first and second improvements. Bealey had always relied on return flows from the actions of Shaw’s predecessors. Under the first occupancy doctrine, this would have granted Shaw’s predecessors the right as first occupants to the flows they were appropriating and Bealey the right as first occupant to the flows he was appropriating. However, Shaw’s predecessors’ 1791 improvement, which was upstream from Bealey, carried water back into the stream through an exit sluice downstream from Bealey, meaning that Bealey could no longer access return flows, leaving him with insufficient water to keep -­‐88-­‐ his own mill running. But, Bealey and Shaw’s predecessors had been able to come to an agreement, after the second improvement in 1791, that Shaw’s predecessors would allow some of their water to flow to Bealey when they did not need it, which kept Bealey’s mill running. A mutually beneficial bargain had been struck. Shaw’s predecessors presumably recognized Bealey’s occupancy right and, instead of going to court, let Bealey use their surplus, which kept Bealey afloat. Bealey, in fact, had a right to more than simply the surplus, but “the plaintiff to avoid litigation agreed during that time to receive his right in a manner more abridged than he need have done” (Bealey, p. 1269). It was clear to both parties, then, that Bealey could take Shaw’s predecessors to court, but they bargained in a way that Bealey was satisfied with instead, given that the right to this surplus water was legally Bealey’s under the first occupancy doctrine. Accessing the courts in order to establish a right was unnecessary because the two parties informally recognized Bealey’s right and, from there, voluntarily bargained; a good example of the Coase Theorem at work through an informal recognition of rights. However, in 1799, when Shaw succeeded to his predecessors’ mills, he increased his diversion activities, leaving Bealey, once again, with insufficient water to continue his milling operations. Shaw was unwilling to recognize Bealey’s right to the water and refused to uphold the deal Bealey had struck with his predecessors. Thus, Bealey brought Shaw to court to get the initial rights placed formally. The court held that Bealey had the right of first occupancy to the flows he had been utilizing because, prior to the 1791 improvements on Shaw’s -­‐89-­‐ estate, Bealey had been the first occupant of the water Shaw’s predecessors had not appropriated for themselves under their own first occupancy right. The court stated that “[Bealey] had a right to all the water flowing over his own estate, subject only to the easement which [Shaw’s predecessors] might have in it in respect of the premises which they occupied higher up the river” (Bealey, p. 1269) and that Shaw’s increase in diversion of flows “incroached on his right, and deprived him of a benefit which was attached to his estate” (Bealey, p. 1269). Thus, the court affirmed Bealey’s right to the unappropriated surplus of Shaw’s predecessors. This is a clear expression of the occupancy doctrine. Further, the court claimed that “[Shaw’s predecessors] had established before 1787 a right by user to appropriate part of the stream” (Bealey, p. 1270) and that “if the occupiers of [Shaw’s] premises could before have appropriated to themselves any part of the water flowing through their own lands, by the same rule those through whose lands it afterwards flowed might appropriate so much as had not been appropriated by others” (Bealey, p. 1270). This last claim is essentially the definition of the occupancy doctrine. When Shaw’s predecessors first established on this waterway, they were the first occupants and were allowed to appropriate as much water as they could put to productive use, but they chose not to appropriate the entire stream. Then, when Bealey came along and began appropriating those volumes of water that Shaw’s predecessors had decided to forego, he became the first occupant of that surplus water flow. Both Bealey and Shaw had their appropriations protected by this doctrine, which is why the court -­‐90-­‐ decided in favor of Bealey, legally restricting Shaw from overstepping his legal limits and appropriating some of the water to which Bealey was legally entitled. The consequence of employing the occupancy doctrine in place of the ancient use doctrine might have made little practical difference in this case. Not long before this suit was brought to court, Bealey and Shaw’s immediate predecessor were able to bargain and come to an agreement. Presumably, Bealey and Shaw could do the same thing if it were productive once the rights had been delineated. Whether first occupancy or ancient use was employed, given a low transaction cost scenario where bargaining had occurred before, the HVO should have been able to either maintain their right if initially endowed with it, or bargain for the right in a voluntary, mutually beneficial transaction. To be clear, in any low transaction cost scenario, it matters not for the purpose of producing the efficient result what rule is employed so long as rights are delineated in some way. This is the fundamental insight of Coase and always deserves reference. This new ruling did, of course, favor newcomers distributionally, which was surely one of the main purposes of its applications, so as to encourage innovation, investment, and economic growth, the driving sentiment of the industrial period, and the bearer of increases in productive value in use of resources, including water. Rather than presume the ancient user was the HVO and force newcomers into a bargain, the occupancy doctrine assumed newcomers were the HVOs, and forced ancient users into a bargain. Further, first occupancy only protected the right of first occupants to that which they were actually using, as opposed to the entire river flow along their -­‐91-­‐ section of stream, which had historically been the case under the ancient use doctrine. This increased the number of individuals that could settle along a stream and engage in productive use of the river flows, increasing the overall productive value of the water. Individuals, such as Bealey, could settle along rivers freely and appropriate the surplus flows, protected by their own first occupancy rights, without having to first engage in a bargain with either an ancient user who owned the rights to the flows of that entire section of river or many other first occupants who owned only marginal rights to the river flows. Additionally, given increasing numbers of users of England’s waterways, the occupancy doctrine made transfer of rights easy because one had only to transfer their first occupancy right to the HVO in a single bargain without bargaining with other users, because other users would not be affected. This had the effect of keeping transaction costs low under a scenario where they could have become prohibitive. The new HVO would still only have the first occupancy right to the water the previous first occupant had, which was not adverse to any other users’ rights. Additional Clarifications and Considerations I would like to be clear, for a moment, that the first occupancy doctrine did not simply split ancient users into one demographic, all newcomers into another demographic, and allow all newcomers investing in capital to take over the ancient users. If an ancient user were also the first to invest in capital, they would gain the right of first occupancy, which would be protected from subsequent newcomers. This is the way that Shaw and Shaw’s predecessors had -­‐92-­‐ their original diversions protected by the court in Bealey v. Shaw. They were originally ancient users but had earned the right to first occupancy because they had invested capital in the river. This, just like the ancient use doctrine, then permitted productive bargains with the ancient users, now first occupants, to take place, should a newcomer be the HVO. It is important to remember, though, that it is possible that the utility gained by some ancient recreational users in their simple enjoyment of an unimpeded flow was high enough to deter bargains with newcomers when these ancient users were initially endowed with the right to the water through the ancient use doctrine. Recreational use was not protected under the first occupancy doctrine, though, without involvement of a capital investment. The first occupancy doctrine, by erasing the right of these ancient users to sit on ancient flows without putting them to use with capital-­‐
intensive production, forced these ancient users to back up their utility valuations with effective demand. If an ancient user, devoid, now, of his ancient use right, was still the HVO, he could still bargain with the newcomer who had gained a first occupancy right given low transaction costs if he were truly the HVO. The efficient outcome was still possible; the rule just favored the newcomers distributionally. Indeed, given the caveat to the Coase Theorem about effective demand, there certainly must have been some ancient recreational users who, once they lost their prescriptive right, did not actually have the effective demand to back up their utility claims, in which case they could not strike bargains with competing users. There might not have been many, given that these ancient -­‐93-­‐ users usually had money, but there would have certainly been some. The first occupancy doctrine would restrict the protection of their utility given a lack of effective demand. This transformation of entitlements reflects increased weight placed on the productive value of goods produced through capital expenditures that contributed to increasing economic growth, trade, and material wealth. As Carol Rose puts it, “In the early period of rapid industrialization and change, the great value of capital-­‐intensive uses must have seemed obvious compared to less intensive uses, if for no other reason than the common tendency, sometimes evident in our own time as well, to overvalue the contributions of new technology while underestimating its dislocations” (Rose, p. 280-­‐281). Mendels also supports this point by noting that the British were so eager to encourage industrialization and the utilization of unemployed labor in the expansion of their economic prowess that “when local skills were not sufficient, entrepreneurs or governments often invited foreigners to help build the modern industry” (Mendels, p. 245). Old riparian landowners, satisfied by the simple pleasures of a rural life and an undisturbed river, no longer carried the same weight that they had in the past. It was no longer sufficient to protect these outdated recreational and aesthetic values. The industrial age of England was dawning, value in production was the measure of efficiency, and there was no place for utility that was not backed up by effective demand. Thus, placing water rights in the hands of ancient recreational users could still produce efficient results, given easy bargaining. No one, however, would have wanted to burden investors with the task of bargaining with an ancient recreational user, -­‐94-­‐ especially if that user might not bargain given an astoundingly high utility valuation in conserving the land and the water. Effective demand became the primary way to determine productive value. The conversion to the occupancy doctrine was not long lasting. It quickly became clear that, while it was productive when it was first implemented, industrial growth, population growth, and a growing number of uses for water was introducing too many factors for the occupancy doctrine to effectively handle. The next section will uncover the workings of the reasonable use doctrine, pointing out the importance of a major shift in the transaction costs associated with bargains over water rights. Up until the application of reasonable use, transaction costs had been low. But new economic conditions characterized the use of water and increased transaction costs, calling attention to the need for a new water rights rule. These economic conditions also help to explain why Britain kept the reasonable use doctrine while California, a state that was subject to different economic conditions, would adopt a wholly different set of rules. The end of this section will lead into Chapter 3, where I will cover the late nineteenth century application of California common law water rights. GOVERNANCE THROUGH THE RULE OF REASONABLE USE The Conditions That Necessitated a New Rule While the British economy continued to leap forward into the age of industrialization, the British courts continued to try to stay current, adopting new rules as new conditions demanded it. Demand for water remained high as -­‐95-­‐ new users and innovators sought access to England’s waterways. Perhaps most important was the realization that industrial uses produced pollution, which could affect many users downstream. As a result, every new use of the water had the potential to affect numbers of users downstream due to pollution, as well as numbers of users upstream due to the construction of a dam that caused backflow and flooding. The occupancy doctrine did not effectively address an issue like pollution, nor an issue like damming that caused flooding on the lands of multiple landowners upstream. The transaction costs required to organize a bargain with everyone affected by pollution, or with everyone damaged by flooding from a very large dam, would likely be too cumbersome to come to a productive agreement even if those harmed were, collectively, the HVOs of the right either to be free from pollution or to be free from flooding. On top of the typical costs of carrying out a bargain, recall from Chapter 1 the difficulties of dealing with holdouts and free riders. As the number of parties to a transaction increases, these problems are only exacerbated. The courts responded appropriately in order to continue maximizing the productive value of England’s waterways, adopting the rule of reasonable use, a rule that was already in use across the pond in Massachusetts. The reasonable use rule that England adopted was one of equal correlative rights: “first, riparian owners had limited but more or less equal rights to use the stream; second, their various uses could cause some inconveniences to other owners; and, third, those inconveniences were not actionable if they were merely minor” (Rose, p. 283). It was a very vague rule, but purposefully so. All users had equal rights to use the -­‐96-­‐ stream flows, and individuals could only bring one another to court if there were significant damages supported by factual evidence. England was very similar to Massachusetts in that both regions had plenty of rain, so agriculture did not require significant consumption of surface water, and most uses of water were for power generation, which was also a very low consumer of surface water. Even when agriculture did require surface water irrigation, it was on riparian lands, so there were significant return flows to the stream from which the irrigation water came. As a result, most water uses did not substantially affect stream flows, except through the discharge of pollution. The reasonable use rule was the most appropriate rule, given these economic conditions, to maximize the productive value of surface water and achieve the efficient allocation of water rights. I will show this in the ensuing discussion. The rule was first adopted in Embrey v. Owen in 1851 (Embrey v. Owen, 155 ER 579), leading the way for the universal adoption of this rule across Britain. Embrey v. Owen: An Illustrative Case Both Embrey and Owen had been appropriating water for various uses, including mills, small-­‐scale irrigation, domestic uses, and watering of cattle. Owen, however, did not always use water for irrigation, only intermittently, and not substantially. The majority of days, Owen was not irrigating, using the water instead for other purposes, so irrigation days were unusual and episodic. To Embrey, these irregular days of irrigation, on which that Owen was diverting a greater volume of water, represented an affront to his appropriative rights -­‐97-­‐ under the occupancy doctrine. Embrey claimed actionable damages to his interests, which were not upheld. The judgment was a clear-­‐cut reasonable use decision. The court, through scientific and witness testimony, determined that, first, Owen’s diversions for irrigation were indeed episodic, and, second, that the reduction in stream flow was negligible and did not cause any damages to Embrey. The court held for Owen because there was no harm to Embrey’s interest and Embrey had no case. Still, the ruling said more than this, outlining the reasonable use rule in a way that set a precedent for subsequent rulings. The facts of this case could have been slightly different, in that there could have been minor damages to Embrey, but the court still would have ruled the same way, which is why it was so important that it detail the workings of the reasonable use doctrine. The court made the argument that, due to water’s transient quality, the fact that it flowed past the land and was therefore unstable, no individual could ever own the right to the entire stream flow, or even to a substantial piece of it. “Every proprietor upon each bank, to the middle thread of the stream…has a right to the use of the water flowing over it in its natural current… But, strictly speaking, he has no property in the water itself, but a simple use of it while it passes along… No proprietor has a right to use the water to the prejudice of another…the right being common to all the proprietors on the river” (Embrey, p. 584). The river was, in a sense, a public good owned in common by all riparian landowners of the state, but a good that could only be used in such a way that significant damages would not be imposed upon upstream or downstream -­‐98-­‐ appropriators. Thus, small harms to the individual were acceptable to the law so long as they were not significant. Every individual appropriator was granted the private property right to appropriate that which was reasonable, which was essentially understood to be a relatively equal portion of water flows, or “equal correlative rights” (Rose, p. 287). Every individual was also allowed to harm upstream and downstream users by only so small an amount as was necessarily produced by the active use of the river. In Embrey v. Owen, no damages had accrued to Embrey, and thus Embrey had no case. But rather than give either Embrey or Owen an exclusive right to some volume of water and protect that interest against competing users in the face of future damages, the court gave both of them equal rights, in the same way that all users had equal rights, that could be protected against significant harm caused by anyone. At the same time, they could not be protected against insignificant harm produced by everyone else that was caused by the active use of the same river, whether it was to build a mill or to use a little water for irrigation or the watering of cattle. Uses were only negligibly consumptive, so small the courts permitted harms to everyone produced by everyone. Reasonable use was, thus, the equal correlative use of the river – correlative referring to an equal right to water proportionate to the extent of one’s landownership – empowered each rights holder to use or consume their fair share of the flows. Insignificant damages were tolerated as reasonable, while significant damages were deemed unreasonable. -­‐99-­‐ The consequence of this rule was to allow a much greater number of users to occupy a given stream. Instead of allowing users to sue each other for small damages, these small damages were assumed to be part of the natural use of the river. Allowing small damages was productive because it increased the number of investors and entrepreneurs that could legally establish production along a stream. This, in turn, created great productive value in use of the streams at only a small cost, attributed to small mutual damages shared by everyone. Recall the massive transaction costs associated with bargaining with large numbers of people, and how this problem is made even more difficult with the presence of holdouts and free riders. Under another rule that granted private property rights, like the first occupancy doctrine, every time a new user – who could produce great profits by using the river while causing only minimal damages to everyone else due to reduced stream flows – wanted to establish along a stream, they would have to bargain with all the upstream or downstream users they would affect by their added use of the stream, even if damages were only minimal. Even though this added production would increase the productive value of the river, the transaction costs might be too steep to foster a bargain. Consider, also, the case in which a water user introduced a negligible amount of pollution into the river that harmed downstream users in an insignificant way. Under the first occupancy doctrine, each downstream user would have the right to restrict this pollution. But, given that the pollution was small, the benefit of allowing additional users along a stream, producing large benefits and only small damages, would increase the total productivity of the -­‐100-­‐ river. In the case that either pollution was significant or a diversion was significant enough to cause damages downstream, these damages would be cause for a suit, and those injured would be due compensation. Requiring compensation when there were appreciable damages helped to ensure that the damaging source had to be the HVO, otherwise they would not be able to pay the damages and would have to discontinue production. But, again, most uses, at least at the time that reasonable use was most appropriate, were generally non-­‐
consumers or low-­‐consumers of river water, and producers would simply have to regulate their pollution levels or dump it somewhere where it did not affect the water supply. Gone was the ancient use doctrine, and gone was the occupancy doctrine. Reasonable use was a completely new law, differing drastically from prior doctrines, and it was very appropriate given the prevailing transaction costs and economic conditions of surface water. Given increasing industrialization, innovation, and improvements in technology, it could no longer be assumed that the first occupant or the ancient user was the HVO. For bargaining purposes, in a low transaction cost setting, it would, again, not matter which party was granted the initial right, because efficiency could be achieved through negotiations. But, given greater numbers of users, there could often be insurmountable transaction costs. Not only did the new reasonable use doctrine recognize the fact that newcomers could be the HVOs, thus handing them the right to establish along the river and divert to a reasonable degree without significant damages, but it also capitalized on increasing transaction costs. Allowing small damages created -­‐101-­‐ by all the water users to be spread across all the water users greatly increased the benefits that water users could produce on aggregate, given only small costs produced. This provided the public good of maximum development of the river, achieving the maximum possible value in ownership of water rights. The right of reasonable use was a great solution, allowing new and productive uses of the water to join the other appropriators along the stream, but also to protect those already using the stream by disallowing significant damages. It achieved both what seemed to be a fair distribution of the resource, not stripping existing users of their rights, while simultaneously granting new users a crack at producing profits. The social value along the river could be maximized in this way, welcoming newcomers as opposed to wholly excluding them. Moreover, in those cases where damages might have accrued only to one or a few other appropriators, transaction costs might still have been low enough to allow for bargaining to occur, especially if users were increasing in numbers but where their density might still have been low. For example, it might have been most profitable for three downstream appropriators damaged by a new, upstream industrial use of the water, an action that might have been brought to court because it violated the reasonable use doctrine, to join production operations with the upstream industrial use, or to elicit payments for damages. Likewise, a user who wanted to build a large dam that might cause significant damages could choose a spot where there was a lower density of users and transact with them, perhaps subsuming them under his operations or -­‐102-­‐ compensating them for the damages. This would allow the HVO owner to emerge, as well, producing the efficient result. CONCLUSION English common law evolved to appropriately match the prevailing transaction costs and economic conditions. In an environment of low transaction costs and stable, long-­‐term applications of watercourses, it made sense to employ the ancient use doctrine, presuming that the most ancient user was the HVO. In the case that he was not, low transaction costs, on aggregate, permitted mutually beneficial bargaining, and thus the efficient allocation of rights. In an environment of low transaction costs but with moderately quick transformation of technology, production processes, and applications of the water, and given that there were a number of ancient users that merely enjoyed their watercourse but valued it only for recreation or its aesthetic beauty, the presumption that the ancient user was the HVO no longer held as frequently. While bargains still could have achieved efficiency, it made sense to employ the occupancy doctrine, reallocating entitlements to those who made the first capital investment under the presumption that they were the true HVO. Ancient users, too, could be those who had employed capital and would be protected by first occupancy. In those cases where the first individuals to invest in capital-­‐
intensive production were not the HVOs, bargains could still occur to achieve the efficient outcome. Indeed, some ancient users without effective demand to back up utility valuations would be neglected and would lose out, distributionally, but it -­‐103-­‐ seemed to the judges that this utility was less valuable socially than it used to be in the face of ever-­‐increasing productive value in the employment of resources like water. The beauty of the common law is its ability to adapt. It did just this, adapting to a growing societal weight placed on economic value in production. The new rights structure forced ancient users to prove that they were the HVOs of water rights with effective demand, backing up utility value with economic value. Utility value had been given a back seat to economic value in the face of industrialization. Lastly, in an environment of increasingly steep transaction costs, framed by the transition into an industrial era of greatly increasing production values, the assumption that new users might be higher-­‐valuing owners than previous users, and that bargaining would largely be out of the question, was congruent with reality. The reasonable use doctrine accomplished the task of protecting the rights of previous investors, but also admitting new users to establish their operations along the stream. This maximized the social value of production, achieving the efficient outcome. It is important to reiterate, before the transition into Chapter 3, that there was a fundamental difference between water use in England and water use in California. Worldwide, agricultural irrigation is by far the greatest consumer of water. This was no less true in the 1800s than it is now. In England, there was plenty of rainfall, which made surface water irrigation largely unnecessary for agricultural production. Because of this, the main use of surface water was water-­‐fueled power generation. In California, there was very little rainfall compared to England. Thus, irrigation was the main use to which rivers were -­‐104-­‐ put, and the act of irrigating consumed almost all the water that was diverted with very little return flow. This was a radically different economic condition under which appropriators in California operated. As a result, the reasonable use doctrine was not enough to govern watercourses, because what was reasonable had a very different meaning for an irrigator than for a mill owner. Mill owners hardly consumed any of the water they diverted, whereas irrigators in California consumed almost all of the water they diverted. This had a profound effect on the resulting rules that were instituted in the California common law to govern water use. -­‐105-­‐ Chapter 3 INTRODUCTION The development of California water law over the past one hundred fifty years provides additional compelling evidence to support the central idea of this thesis, that idea being: the governance structures for water have, should, and will evolve as the economic conditions and transaction cost environments framing water use transform over time, in order that the law may facilitate the efficient allocation of water rights. Law that was appropriate for rainy New England or England in the nineteenth century, where the main use of rivers and streams was nonconsumptive power generation, would ultimately not be appropriate for the arid western regions of the United States where the main uses of rivers and streams were the consumptive activities of miners and irrigators. The economic conditions were different, and the state of the resource was different, and still is. These differences played a key role in determining which governance structures would ultimately be the most appropriate for achieving the efficient allocation of property rights. The riparian right of reasonable use was an appropriate rule for England because it maximized the number of users on every stream and eliminated the necessity of transactions in the face of mounting transaction costs, thus -­‐106-­‐ maximizing the productive value of those streams. Reasonable use was adopted by California on private lands where it would be the primary governance structure for surface water. Given the different climate conditions in California, it seemed odd that California would adopt an English rule founded in climatic conditions of abundant and consistent rainwater. It seems its adoption was as much a legal oversight as it was at first an appropriate decision. The State of California adopted the English common law as the law of the land when it gained statehood, but likely did not recognize that this would also mean the adoption of riparian law as well (Kanazawa, p. 164). However, given a very low population density in the middle of the century, and thus low transaction costs, any endowment of rights would have sufficed to induce efficient bargaining, so reasonable use might have, after all, been an efficient rule. This would slowly change, however, as the population of California began to grow exponentially late into the nineteenth century and early into the twentieth century, and the majority of water uses were to be found on nonriparian land. As a result, the rule of prior appropriation began to take hold, competing with reasonable use throughout the remainder of the nineteenth century, eventually becoming adopted statewide as the primary water right overseen by a statewide administrative board. The twentieth century of California water rights will be discussed in Chapter 4, but it is central to this chapter to understand the importance of prior appropriation. The rule of prior appropriation permits the rights holder to appropriate a specific volumetric portion of the river flow to which they have been granted a -­‐107-­‐ permit by a local or regional administrative board, or, in the twentieth century, a state administrative board. This right by permit could then be adjudicated in the state courts like any other common law doctrine. It is also interchangeable with the name appropriative right, which I will use often throughout this chapter. Some uses of watercourses required both precise volumes of water for their heavily water-­‐consuming activities as well as diversions of that water to uses on nonriparian land. Reasonable use was not always enough to induce the efficient outcome in these circumstances, and conditions demanded a new rule. Prior appropriation filled that gap, giving users the precision and consistency of volumetric permits, but also the right to divert water to productive uses on nonriparian lands, of which there were many as the population grew in this arid state with few streams and rivers. Other uses, still, did not need such precision, or involved water applications on riparian land, and in these cases reasonable use was more appropriate, in that the riparian landowner was either already the highest-­‐valuing owner (HVO), or transaction costs were low enough to allow for productive negotiations. Throughout the second half of the nineteenth century, while reasonable use was the official water right on private lands, prior appropriation would slowly gain favor in court decisions. I will show that judges appeared cognizant of and knowledgeable about the consequences of their decisions, and would, in fact, use either of these rules depending on the economic circumstances in order to achieve the efficient allocation of rights. The story begins on federal lands in the 1850s, however, where the mining activities of the Gold Rush primarily took place. In the mining camps of -­‐108-­‐ California on federally owned lands, there was also a mixture of water rights rules employed. Early miners could find gold directly in the riverbed, called placer deposits, and therefore needed nothing more than a riparian right to protect their activities. Because miners were on federal lands that they did not own, however, these rights were merely informal, enforced by custom and norm. Riparian rights for miners initially took both the form of reasonable use as well as first occupancy. Which rule was used depended on what the needs of the miners were and how many of them existed in one area. Recall that first occupancy protects the first individual to invest capital in the use of a river from all newcomers along their stretch of river. Because rights were informally enforced, miners were capable of choosing whichever right most benefitted them in their own locale. As these placer deposits ran out of gold, however, miners often needed to divert water away from streams to nonriparian lands where greater numbers of gold mines could be found. Reasonable use and first occupancy only applied to riparian users, and so miners quickly realized that prior appropriation was the necessary governance structure to allow individuals to access the wealth to be found in nonriparian mines. The rule of prior appropriation, in fact, became the official federally mandated water rights rule on federal lands in California. In this Chapter, I begin with an overview of all early California water rights as somewhat of an extension to this introduction. I then dive into the nature of mining camps in California, and how and why the law evolved from the informal application of riparian rights of reasonable use and first occupancy to a -­‐109-­‐ more formal application of prior appropriation, with permits distributed by local administrative boards and conflicts adjudicated by courts. I then jump in to the story of water rights on private lands in California, showing how the riparian right of reasonable use would coexist alongside the right of prior appropriation, and how this concurrent existence worked smoothly until conditions would demand, as I explain in Chapter 4, that prior appropriation become the dominant water right in California. NINETEENTH CENTURY CALIFORNIA WATER LAW An Overview of Early California Water Rights In the early nineteenth century, American pioneers were pushing westward across the great expanse of land that currently constitutes the United States. They began to settle down and establish stable communities around the middle of the century, at which time many territories started earning statehood. With formal statehood, it was necessary to construct the legal institutions of the state, including all administrative, monitoring, enforcement, and adjudicative capacities. Most western states copied the east and adopted the English common law as the reigning set of rules over all legal matters since they had already been using it where they could. California was among these states, both gaining statehood and formally decreeing the rule of English common law as the law of the land in 1850. Adopting the English common law was initially logical because most other states across the country were employing this set of rules. As a result, it was much easier to find the necessary legal texts as well as lawyers and judges -­‐110-­‐ trained and experienced in this law, which would reduce the cost and uncertainty of legal rulings (Kanazawa, p. 164). The adoption of English common law to govern all legal matters included the governance of water rights. What this meant for surface water, both rivers and lakes, was that riparian rights were to prevail, and they were to be governed by reasonable use, the same as riparian rights in England at the time. At first, reasonable use was defined as granting all riparian users along the same surface water source common access to that source, so long as no damages were imposed upon another riparian user through one’s own riparian use of the water. This was the no-­‐injury principle. Later in the century, reasonable use would evolve to grant all riparians equal correlative rights, which effectively gave each riparian the right to as much water as was proportionate to their land ownership. Injury constituted deprivation of this equal correlative, or proportionate, right. The former application of reasonable use, the no injury principle, was appropriate in California at first because there were not many people established in the west. Thus, with plenty of room to settle in the open west, conflicts on waterways would either be settled through the no-­‐injury principle, sending the newcomer on his or her way to establish elsewhere, or through a mutually beneficial bargain, whereby the newcomer would have to pay for the water rights of the established riparian. This rule operated in much the same way as the first occupancy doctrine, discussed in Chapter 2, which protected the first investment in capital against all newcomers. While the no injury principle -­‐111-­‐ was often formally applied to water issues, there were also strong local customs that dictated how water would be allocated. Some communities of users were able to fit numerous water users along a given stream, either following an informal rule of reasonable use under equal correlative rights, or an informal rule that divided up stream volumes among the various riparian users. The latter rule was almost like a rule of prior appropriation, but as applied to riparian rights informally. In the case that local customs were strong enough to overcome conflict, and to administer informal rights, increasing the productive value of waterways, the law was irrelevant. Or, put another way, the users informally created their own law of water, enforced by custom and consent, to achieve the efficient allocation of rights. Still, in the case that conflict arose, reasonable use under the no-­‐injury principle could work well with low numbers of users and low transaction costs. Still early in California’s history, however, more and more Californians realized that the English common law of reasonable use, in either form, was not always the most useful rule to govern water rights allocation. With limited rainfall, few rivers, irrigation-­‐intensive farming practices, consumptive mining operations, increasing demand, and many nonriparian uses for water, reasonable use was not the most productive rule to govern water rights. An important characteristic of reasonable use is that it, inherently, only applied to riparian uses. But given the paucity of waterways and rainfall in the west, there was often the potential for very productive uses of water on nonriparian land. Early Californian water users often realized that diverting water away from -­‐112-­‐ riparian lands would be necessary in order for economic progress to continue leaping forward. Under such conditions, especially given the consumptive nature of most water uses in the west, it was necessary to take the simple, well-­‐defined property rights of reasonable use and to split them up into smaller appropriative rights and expand their application to nonriparian lands. The no-­‐injury principle effectively gave those already established along a river protection against all competing uses that might inflict damage upon their operations. But rivers and streams had far more productive value to be extracted with rights to much smaller portions of stream flows granted to a far greater number of individuals, endowing individuals only with the volume of water they needed and no more. Water users in California hardly ever needed entire stream flows, but rather only a portion of them. Indeed, the reasonable use rule of equal correlative rights, employed later in the century, essentially divided up watercourses into portions according to the extent of landownership, but it still limited uses to riparian lands, leaving many potentially profitable nonriparian uses in lack of water. Divvying up the water into greater numbers of portions and utilizing them on nonriparian lands would produce tremendous value increases. Nonriparian users were often the HVOs of the water, but they found it difficult to legally get their hands on water rights. One water user protected by reasonable use might have trouble negotiating with multiple newcomers, in the face of transaction costs, even if an efficient negotiation would be possible, one that would increase the number of users along that stretch of river and, as a result, the productivity of the river. Under reasonable use, then, the efficient -­‐113-­‐ result would not always be achieved, whereas prior appropriation, which grants each appropriator a specific amount of water and no more, would increase the number of users along that river through the mere permitting of water, allowing more people to access, through use, the value of the water. Growing Importance of Prior Appropriation As a result of these concerns, the new rule that began to grow in application in the middle of the century was none other than prior appropriation. Technically speaking, the first appropriator was the local government, which then had the power to deal out permits to private appropriators. These private appropriators were endowed with this appropriative right from the government, be it a local or administrative body. These permits determined what volume of water an individual would be endowed with, which left the rest of the stream flows to other “appropriators,” representing rights that could be adjudicated by the state courts. Prior appropriation only gave the first individual, and all subsequent appropriators, the water they needed for their operations. Rights were also stacked in a hierarchy, defining them in terms of seniority. In times of scarcity and drought, junior rights holders were the first ones to forego appropriative privileges. This may not have been the most efficient rule, given that there is no reason why senior rights holders are the ones who could be the most productive with the scarce water in times of drought. But local courts were limited in their capacities to determine who might the HVOs of a given set of water rights during times of extreme scarcity. It was likely an insurmountable task to determine, during all times of drought, how -­‐114-­‐ much water was in the river, which appropriators would use the water most efficiently, how to make sure these appropriators got the water they needed, and how to deal with the non-­‐priority appropriators that would argue every year that they, in fact, were the HVOs. Seniority priority rules, at the very least, were a way of establishing and guaranteeing hierarchies of rights during drought, ensuring consistency, and eliminating uncertainty, all of which were important in facilitating smooth and predictable transactions among users. Furthermore, given that rights were divestible, there was nothing stopping junior rights holders from buying water from senior rights holders during times of scarcity, other than transaction costs. But, given that rights were defined by volumes of water that, if merely transferred to another user, would have no effect on the rights of others, a buyer did not have to interact with any appropriator except the one from whom the buyer wanted to obtain a water right. This made transactions a bilateral event, which was less likely to produce the kinds of prohibitive transaction costs that would deter efficient, mutually beneficial bargains. The act of diversion also helped make this possible, given that water was funneled by appropriators through diversion ditches and flumes from streams to their final destination on nonriparian land, allowing appropriators to, while crudely, measure their appropriations as accurately as possible. Water rights representing relatively accurate volumes of water could then be transferred to willing buyers. This is one of the reasons diversion was a necessary prerequisite to gaining an appropriative right, which I discuss at greater length below. -­‐115-­‐ Limitations on Prior Appropriation There were three limitations to the right of prior appropriation. The first limitation was that the use had to be beneficial (Pisani, p. 14), in that the use had to produce economic value. This hardly made any practical difference because any use that had productive value could be argued to be beneficial. The only practical significance this likely had was to limit recreational and conservational applications of rights. As will be discussed more fully later on, agriculture and gold mining were the main source of economic value for waterways. It was not in the vocabulary of the common man in California to consider waterways for their recreational or conservational purposes. The productive value was in mining and agriculture. Thus, to the people of the era, the rule of beneficial use was an efficient rule, limiting uses to those that were considered truly productive. While this may have produced negative long-­‐term consequences for the capacity of individuals to maximize the value of production – given the negative effects of over-­‐appropriation upon the health of the resource and stability of the resource, something to be discussed further in Chapter 4 with respect to the modern era of water law – these potential consequences were unknown at the time, so beneficial use was a good tool. The second limitation on prior appropriation was that there had to be a diversion of the water, whether it was from a river or a lake, in order to establish a right. This helped to guarantee that the use of water would be a beneficial one. It protected against speculative claims by requiring actual use, investment in capital, and construction of ditches (Johnson, p. 385). Only an individual who had -­‐116-­‐ invested substantially in their project, who believed it would be profitable, would expend the time, resources, and effort necessary to construct and maintain diversion ditches that could stretch for miles. Diversion, secondly, made it easier to adjudicate appropriative rights. Requiring that users have diversion ditches allowed for appropriators to more easily measure out their water right in volume because diversion ditches would have a certain width and height. This allowed permits for volumes of water to be more accurate, despite the difficulty at the time, given limited technology and hydrological knowledge, of administering very accurate water permits. Indeed, this lack of precision in permits, in conjunction with very limited understanding both by private users and by the courts of how much water was in watercourses as well as how much water was actually necessary for certain activities, often resulted in the over-­‐allocation of rights to streams (i.e. that there were more rights to water permitted than there was water in streams). At times, this over-­‐
allocation could be extreme. The Salt River in Arizona was allocated twenty-­‐five times over, and the San Joaquin River in central California up to one hundred seventy-­‐two times over (Pisani, p. 14). While some measure of over-­‐allocation must have been the case for many waterways, prior appropriation, even with this crude level of measurement, still allowed for the greatest value in use of the water to be achieved. Given that scientific knowledge and methods of measurement were limited, the assumption must have been that the occasional lawsuit between appropriators due to over-­‐allocation was worth the cost of adjudication when compared to the loss in productive value of dissolving prior -­‐117-­‐ appropriation and exclusively implementing reasonable use once more. Moreover, because over-­‐allocation was a direct result of limited knowledge and information, the consequences were probably limited given that users likely used only a small fraction of what they were legally allocated, given that private user would often overestimate their own use needs. Third, requiring a diversion was consistent with the general reality that there were many places far from riparian land in desperate need of water, whether a town, a small city, or some site of productive activity, in order to grow and thrive (Johnson, p. 348). If one were diverting water, then, it was presumed that they were likely the HVO of that water right, producing great value on nonriparian lands. Finally, a diversion, though crudely measured, allowed for greater efficiency in the transfer of water rights to occur. Settlers were becoming more numerous by 1880, as the population of the west grew ever larger, but prior appropriation drastically reduced transaction costs. If twenty appropriators had received permits to volumes of water that, collectively, would divert the entirety of the stream flows along a waterway, then the only way for an individual to gain access to water would be to try to defend an even earlier claim of prior appropriation or to buy water rights from the existing appropriators. Tricking other appropriators and the courts into believing you had an earlier stake in the water supply would be highly unlikely, given that administrative bodies kept track of permits. What was more likely is that you would try to buy a water right. The beauty of prior appropriation was that you did not have to negotiate with -­‐118-­‐ everyone downstream when you wanted to buy a water right. You only had to negotiate with the individual from whom you wanted to buy water rights. The nature of prior appropriation was that my right did not affect your right, assuming we were appropriators of the same stream. By utilizing my volume of water, I had no affect on your volume of water. Therefore, if I were to transfer my right to someone else, to you it would be as if nothing changed, because the new owner of my water right would be allowed only to use the volume of water associated with that right, which would not infringe upon your right. This drastically decreased transaction costs to bargaining, as mentioned before, facilitating efficient reallocations of water rights through exchange. Recall, for a moment, that, in New England and England, late into the nineteenth century, neither the rule of first occupancy, discussed primarily in Chapter 2, nor prior appropriation was necessary or appropriate. Prior appropriation was not appropriate because uses were not consumptive and users did not have to divert water away from streams in large quantities. First occupancy was not appropriate because it would protect the first mover against all potentially adverse parties, even ones that inflicted minimal damages. First occupancy worked well before great economic growth, as was seen in Chapter 2, because there were fewer people along streams, and conflicts could be settled bilaterally with low transaction costs to achieve the efficient allocation of rights. But as the number of users grew, negotiations under first occupancy would have to involve greater numbers of users, which raised transaction costs substantially. The reasonable use rule of equal correlative rights was the alternative, the rule -­‐119-­‐ England ultimately adopted, granting all users established along a stream equal correlative rights to the water, so long as significant damages were not imposed upon other users. Reasonable use became the more appropriate law because water was used mainly for power generation, which caused only marginal damages to downstream users. The courts accepted these marginal damages as necessary under reasonable use; this rule allowed more users to occupy the stream, it reduced administrative and judicial costs, and it eliminated most transactions, maximizing the total value of production. In California, on the other hand, appropriative rights were volumetric and water use was consumptive. If I wanted to buy the right to four acre-­‐feet of diverted water per year from an existing user, I would only have to bargain with that one user. Simply allowing the appropriative right to change hands made no difference to those downstream. Thus, transaction costs were minimized, and HVOs in ownership of rights could buy water rights from lower-­‐valuing owners (LVOs). This took care of both efficiency and distributional welfare concerns; given that no one would be deprived of their vested rights without compensation through a voluntary bargain and the right would end up in the hands of the HVO. The third and final limitation on prior appropriation was that the right only existed in use. Once an appropriator discontinued use of their diversion, they would lose the right to that water. This, like the diversion, was a measure of assurance that the water was being used productively and beneficially. One could not simply own rights to water and sit on them for decades without use. -­‐120-­‐ This type of wasteful non-­‐use was not in the interest of efficiency, and efficiency was in the interest of the state. With such a scarce resource, it was in no one’s interest to have excess water put to no use and thus generate no economic value. Once an appropriator lost their right through non-­‐use, the water returned to the stream and any subsequent appropriator could earn a permit to that water. This rule was also efficient because it guaranteed that water would never sit unproductively in a stream. It represented the condition of aridity in California. It was best for the state of California, its people, and its water users, to allocate water to productive uses only, given this aridity. Thus, California eventually adopted the appropriative right, where it coexisted with the riparian right of reasonable use. This rule is based on, and got its name from, the idea of “appropriation” from the public domain, which dates back to England when the throne technically, though not practically, owned navigable waterways. To take water from these waterways was to legally appropriate an asset from the king. Appropriative rights in the American west in many territories were, at the outset, technically the taking of water from the United States government. Much of the west in the early nineteenth century was federally owned land, divided into huge territories, the American citizens of which eventually attained formal statehood. Thus, to take water from streams on federal land was to appropriate it from the federal government. This was necessary for agricultural and domestic use, as well as the powerhouse of economic development in California: gold mining. -­‐121-­‐ THE GOLD RUSH: THE BIRTH OF PRIOR APPROPRIATION The Conditions That Necessitated A New Rule The adoption of prior appropriation as a water right coexisting with reasonable use was largely influenced by the prominence of gold miners, “49ers,” in early Californian history, thousands of individuals that rushed to the Pacific west in pursuit of riches. Miners in California were numerous by the middle of the century, forming mining camps that often morphed into small townships with businesses, courts, town centers, and irrigated crop fields to feed the community. Out of necessity, the miners used the water of federally owned streams and rivers for their mining operations and irrigation. Most gold was initially found in streambeds, called placer deposits. In order to access these deposits, miners had to live and work on federal lands as squatters. While these activities were technically illegal, Congress was aware of it and made no attempt to stop it. Westward expansion was encouraged in the United States, and mining activities were well received. Western courts took this as a sign of passive submission, and set their own precedents. In the 1853 case of Hicks v. Bell (Hicks v. Bell, 3 Cal 219), a California court affirmed the right of miners to work their mines, despite the fact that they were trespassers on federal land. In 1855, in Fitzgerald v. Urton, the California Supreme Court declared that “[t]he Legislature of our State in the wise exercise of its discretion has seen proper to foster and protect the mining interest as paramount to all others” (Pisani, p. 11). The 1856 case, Conger v. Weaver (Conger v. Weaver, 6 Cal 548) supported the Hicks decision, as did the 1855 California Supreme Court declaration in Fitzgerald, recognizing the -­‐122-­‐ presumption of a grant to the miners implied by Congress’ lack of action on the widespread trespassing by the miners. In a sense, miners had gained a prescriptive right, one in which trespassers gain a right to that which they have been trespassing upon, typically for a duration of at least five years for water rights, if no action is taken by the adverse party. The miners, essentially, had gained a prescriptive right through their uncontested presence on federal lands and appropriation of federal waters, otherwise known as “adverse possession.” The United States government reaffirmed these decisions, and others like them, a little over a decade later when Congress passed the Mining Acts of 1866, which recognized the appropriative rights of miners to use water on federal lands (Kanazawa, p. 168). Both the Hicks and Conger cases, along with the Mining Acts, are examples of the evolution of governance structures to fit more appropriately with prevailing economic conditions. The government could have mined the western lands itself, but it chose not to. Firstly, although the gold legally belonged to the US government, the federal government, headquartered across the continent on the east coast, had neither the manpower nor the ambition to stop all potential gold miners from engaging in mining activities. In a practical sense, the federal government had little control or claim over the west, and it was not going to spend the time and effort to mine this gold when there were already thousands of individuals out west doing just that. The government “might have chartered private companies [to mine the west], retaining a share of the proceeds; it might have charged individual miners for the privilege by issuing licenses…It did none -­‐123-­‐ of these things; they were never considered realistic options. Prior appropriation fitted well with the American expectation that government should provide economic incentives without attempting to regulate industries or fit them into an overall economic plan… It imposed no expense on the state and required no bureaucracy or commission to implement” (Pisani, p. 36-­‐7). The acquisition of this gold and its trade internationally helped to spurn even more trade, fueling American markets with greater private wealth and investment capacity. It must have been clear to the federal government that it would not have sat well with locals to deprive entrepreneurs of the very type of action that made the United States wealthy, that is, an ambitious and expansive spirit. As it was understood then, and to a great extent still today, it was our Manifest Destiny to span the continent, to expand our reach and influence, and to grow and prosper economically. All of that gold in the hands of thousands of enterprising individuals, as opposed to the single iron fist of the federal government, could be applied in thousands of micro-­‐trades and investments, as well as numerous large trades and investments that made the US richer and would encourage growth and drive innovation to fuel greater trade. It, thus, made sense to recognize miners’ rights to squat and work on federal lands, so that they could access the value of western mines. Furthermore, given that mining was a high-­‐value activity, and water was in short supply, it made sense for both state and federal governments to recognize the rights of miners to use water for their purposes in order to capture the gains of production and protect themselves legally from other users. Other than subsistence agriculture, mining -­‐124-­‐ was the primary, if not the only, capitalistic use of surface water in most mining camps and towns during the Gold Rush. Granted, the miners were already doing all of this themselves to a large extent, but it never hurts to have formal law at your back. At first, riparian rights, under the informal rule of first occupancy, worked well enough. The first gold miners were able to extract placer deposits of gold on streambeds and riverbeds, damming watercourses or using water at high pressures to access these deposits, protecting their investments under first occupancy – “first in time, first in right,” as the rule was colloquially expressed. Any diminution of river flow or flooding induced by a second mover’s dam or operations was illegal, and conflicts were either adjudicated or subject to negotiation under low transaction costs given small populations. As I discussed in the introduction, some communities were also able to employ informal variations of reasonable use to effectively and efficiently govern riparian utilization of water for gold mining. Eventually, placer deposits began to run out, but there were many more gold deposits found far removed from streams and rivers. This reality was the primary force that necessitated the evolution from any variation of the riparian right to the right of prior appropriation on federal lands. In order to access these deposits hundreds of yards, and often miles, from waterways, miners had to create diversion flumes and canals from rivers and streams to feed their operations. Realizing that there was great economic growth to be had through further excavation, both Congress and the state courts began -­‐125-­‐ to recognize the right prior appropriation, utilized to divert water to nonriparian land. This was a big move, and it hurt riparian users. In 1877, Congress passed the Desert Land Act, which in fact restricted water use to prior appropriation on public lands (Pisani, p. 12). This eliminated, formally, any riparian right on federal lands, making prior appropriation the official water right on federal lands. No longer could a riparian user, accessing placer deposits in a streambed, be protected from an appropriator upstream or downstream who had locally obtained an appropriative permit and was diverting water to a nonriparian gold mine. It was clear both to the courts and to Congress that protecting riparians on public lands was no longer reasonable. New economic conditions had arisen, and the greatest economic value was found in mining operations utilizing the right of prior appropriation by diversion to nonriparian mines. The evolution of prior appropriation was also directly in line with the philosophy of the time period, one that is still prominent today. In 1839, the Kentucky Supreme Court proclaimed: “the onward spirit of the age must, to a reasonable extent, have its way. The law is made for the times, and will be made or modified by them. The expanded and still expanding genius of the common law should adapt it here, as elsewhere, to the improved and improving conditions of our country and countrymen” (Pisani p. 23). Later in the century, an Arizona court echoed this sentiment, stating that “[t]he essence of the common law is flexibility and adaptability. It is not a body of fixed rules, but is the best product of human reason applied to the premises of the ordinary and extraordinary conditions of life” (Pisani, p. 10). James Willard Hurst, a renowned -­‐126-­‐ legal historian, further declared that law was used “more as an instrument for desired immediate results than as a statement of carefully legitimated, long-­‐
range values,” using Wisconsin as an example, where Americans espoused the belief that “it was common sense and it was good, to use law to multiply the productive power of the economy” (Pisani, p. 8). Another legal historian, Morton Horwitz, supported this claim, asserting “the evolving law of water rights had greater impact than any other branch of law on the effort to adapt private law doctrines to the movement for economic growth” (Pisani p. 9). American citizens believed in economic growth and prosperity, and this belief was mirrored in judicial and legislative decisions. They believed that transforming the law to match the evolving economic conditions and opportunities of the day was the most sensible thing to do, and would allow Americans to thrive, progress, and grow, with the law protecting their best interests. In other words, given new conditions and transaction cost environments, different governance structures were better at achieving the efficient allocation of rights to water. Riparian-­‐Appropriator Conflict in Mining Towns: The Case of William Ware Still, some miners tried to maintain their riparian rights, even as miners all over California were adopting the law of prior appropriation, recognizing the benefits it reaped. In the 1840s, miners arrived in Weaverville, California seeking to excavate mines around Trinity County for precious gold. These were some of the most inaccessible mines in the state. There were placer mines to be unearthed at first, but miners soon had to start moving farther and farther away from the streams, just like miners all over the state. Prior appropriation was the most -­‐127-­‐ appropriate rule for the residents of Weaverville, and yet one of the largest quarrels the area experienced involved a clashing of interests between riparians and a dentist-­‐turned-­‐appropriator named William Ware. In 1850, Ware built three major ditches, not for his own mining activities, but rather to sell water to miners detached from streams. This was a mutually beneficial relationship for both Ware and the miners because building and maintaining ditches over stretches of miles was an arduous task. Miners were often more than willing to pay someone to provide them with consistent, certain flows of water directly to the site of their operations. During wet years, Ware posed no threats to other riparian users downstream, but during the dry winter of 1852-­‐1853, conflict arose. With diminished stream flows, Ware’s appropriative permit allowed him to divert almost the entire watercourse, allowing almost no water to flow to the riparians downstream from Ware that had been informally governing their use of the river through reasonable use. These riparians were aghast at Ware’s actions, and sought the help of an arbiter to settle the dispute. Not only did the riparians claim that they had been there longer, thus invoking the informal doctrine of “first in time, first in right,” but they also believed, contrary to the governing law of prior appropriation, that riparians had a stronger right to the water, mixing into their argument a reasonable use claim given the precedent set by the adoption of the English common law on private lands. But arbitration failed, and the case was brought to the Ninth Judicial District Court for Trinity County in 1854. There, Judge J. W. McCorkle upheld prior appropriation, stating “[t]he beds -­‐128-­‐ of most of the creeks and streams in the mineral regions have been worked out, while extensive gold fields lie unoccupied and untouched yet, for want of water, but which by the construction of canals…will yield good wages to the miners for years to come, and furnish thousands with constant employment, who otherwise would be compelled to lay idle, except during the rainy season” (Pisani, p. 34). McCorkle defended prior appropriation, not only on the grounds that it was the law of the land, but, more important, that it was the rule that would bring about the most long-­‐term wealth for the residents of Trinity County. It as the rule that would efficiently allocate rights to water. This was in line with the philosophy of the day. Prior appropriation was the efficient rule, the rule that allowed miners to realize the greatest total value in ownership of rights to water. Again, placer deposits in streambeds accessed by riparian water users no longer produced the greatest value in mining because these deposits were disappearing, whereas gold mines far removed from rivers were still abundant, and water use for the purpose of accessing these mines would produce both greater short-­‐term and long-­‐term benefits. It was efficient to implement prior appropriation in order to maximize the productive value of waterways. A Distributional Argument, Perhaps? The distributional argument could be made that it was unfair to deprive riparians of fair compensation with a sudden switch of doctrine to prior appropriation, given the time and capital they had invested in their operations. After all, a theoretical bargain could take place that would leave the riparians fairly compensated if new uses truly were more valuable. There are two over-­‐
-­‐129-­‐ arching reasons why this is a poor argument. The most important reason is that, by the time prior appropriation had taken hold, users were more numerous than they had been when riparian rights could facilitate efficient bargains. Indeed, this was part of the reason that prior appropriation was so desirable. In Ware’s case, given one hundred plus miners downstream of his diversion works, and the even greater hundreds of miners Ware had been supplying on nonriparian lands, the transaction costs of negotiation would surely be insurmountable. While a world of zero transaction costs, as I showed in Chapter 1, could have induced an efficient bargain between the riparians and the appropriators, the real world is full of transaction costs. These transaction costs only increase when there are more parties to a bargain. In addition to the typical transaction costs of arranging meetings, agreeing to terms, determining benefits and costs, and so on, there would surely also be holdout problems. In order for Ware to buy the rights to all the water from all one hundred plus miners downstream, he would have to negotiate with each and every one of them. Each individual riparian miner would know that Ware would be gaining a large amount of benefits by reallocating his water right to a different use. Therefore, it would be in the best interest of each individual riparian miner to holdout from negotiations with Ware until they could get their hands on an extra slice of Ware’s benefits. The additional cost involved for Ware in appeasing the holdouts with a greater price for their rights; persuading them to bargain in a cost-­‐ and time-­‐minimizing way by holding expensive community meetings with dinners and cocktails; or simply continuing to negotiate with all of -­‐130-­‐ them individually, would likely render the bargain impossible. Additionally, it would most likely be difficult to negotiate with, and convince, one hundred plus farmers that taking their rights would be in their best interest when they were willing to avenge them by burning down Ware’s house and destroying all of Ware’s diversion ditches. Further, common law decisions often set precedents for future decisions. It would not be in the best interest of the public, that being economic growth and efficiency, to set the precedent that insurmountable transaction costs either had to be surmounted or the higher-­‐valuing use could not legally be realized. One could imagine the imposition of a liability rule, requiring all appropriators to compensate the riparians at the fair market price of their water. One problem with this is that it was not always necessarily the case, nor was it necessarily the case in Weaverville, that every individual appropriator was actually making much more money than every individual riparian. The decision was more about the volume of appropriators versus the volume of riparians. Prior appropriation would serve far more miners into the future than riparian rights. Not only would it allow a greater number of miners to access any given watercourse, but it would also serve the greatest number of miners in general as the source of gold shifted from placer deposits to deposits in mines removed from rivers. This, in turn, would allow California’s miners to produce far more value in use of the water. If prior appropriation truly did raise the total value of production, then theoretically it would be possible to ask every appropriator fed by Ware’s diversion ditches to pay some portion of their profits to the injured -­‐131-­‐ riparians in order to compensate them. But given that every miner was not making the same amount of money, it would be a massive administrative and judicial task to determine how much every miner on both sides would have made, or was making, and then impose compensation liabilities for each appropriator. There would almost certainly be free riders, as well, appropriators on Ware’s side of the bargain that would try to piggyback off the contributions made by other appropriators in order to shirk on their contribution to the liability fund. Dealing with these free riders would also be an administrative and judicial nightmare, one that might rack up transaction costs for the liability rule that would exceed the benefits that would accrue from the imposition of the liability rule. Further, mining was uncertain. There was probably a certain level of statistical return to mining, but beyond that, in a week someone might go broke or hit the jackpot. Judicial determinations with such high uncertainty would be difficult. Also, if a flat rate of compensation were required, this might impose greater costs on some appropriators than they would be earning, making their operations uneconomical. This leads into the second reason why a liability rule would be harmful: it would discourage future investment. Given the uncertainty in the magnitude of profits to be realized, necessary compensation might discourage a large number of miners from appropriating a river already occupied by riparians. This would have been highly undesirable given the value that off-­‐stream mining was capable of producing. -­‐132-­‐ The last, and perhaps the most compelling, reason why a liability rule would not be appropriate is simply because, with the rule change, riparians had no rights claims on public lands and therefore could not defend a nonexistent right. Public land was officially governed by the prior appropriation doctrine, a common law doctrine that protected appropriators and not riparians. To require compensation of riparians would not have made any legal sense. Every time Congress passes new laws, everyone that is hurt is not immediately compensated. The understanding is that the new law is the more appropriate one, effectively eliminating the old law, forcing people to adapt to the law that has been deemed more reasonable, or efficient, as in this case. Compensation is only required when a taking occurs where someone is actually protected by law. The law no longer protected riparian rights. The second overarching reason why the distributional argument is a poor argument is because miners, farmers, and all westerners alike, generally agreed that economic progress was good. Indeed, many miners were ephemeral presences, hoping only to make a quick fortune. Moreover, the nature of mining changed dramatically in the mid-­‐1850s, with the rise of huge water wheels, big buckets, and large water flumes. By 1860, hydraulic and drift mining had almost entirely eliminated small-­‐scale operations (Pisani, p. 34). Capital-­‐intensive operations and economies of scale engendered the most growth, and they took place almost exclusively on nonriparian land. Efficiency, total value of production, and economic growth was the motto of the era, and any riparian miners hoping to combat the evolution of law to serve the interests of efficiency -­‐133-­‐ could not substantiate a very compelling argument. The very same miners that destroyed Ware’s house and tore down his diversion ditches had previously been actively involved in the community trying to build a successful water supply company that could efficiently supply users with water that would maximize the value in ownership of this water. This was true all around the west, not just in California, an arid region comprised of citizens who knew the scarcity value of water and understood the importance of the efficiency of its use. Those encouraging measures to increase efficiency could not support these measures when they favored their own interests, and then expect to successfully and convincingly combat them simply because they no longer served their short-­‐
run interests. GROWING CONFLICT: PRIOR APPROPRIATION VS. RIPARIAN RIGHTS Applying Rules Differentially All this being said about the favorable qualities of appropriative rights, an interesting and important facet of the common law was its ability to change when necessary to fit local needs. While appropriation was generally supreme on federal lands, some riparian supporters held a trump card. Local communities elected judges, so public opinion had a large influence on which judges made it into office (Pisani, p. 36). Given this reality, common law decisions would most likely reflect local needs. This, in a sense, would characterize local judges more as community arbiters than as appliers of strict law. “California court decisions reflected local needs much more than broad legal principles or dicta” (Pisani, p. 36). While prior appropriation might have been most appropriate for the -­‐134-­‐ majority of California’s mining towns, local judges had the discretion to protect riparian rights if it were in the public interest. Indeed, they would be disobeying federal statutory law by doing this, but the one principle always held in the highest regard in the west, especially with respect to that scarcest of resources, water, was that of economic prosperity and progress. The federal government did not have a million set of eyes placed strategically around every mining town, every agricultural community, or at every stream or gold mine. They did not understand the specific conditions of every locale in every region. The local judges were best suited among local communities to adjudicate in the best interest of those local communities. Prior appropriation was still a common law rule, after all, and the brilliance of the common law is its adaptability. No locally elected judge would want to undermine the public interest in growth by, even if it meant acting against federal mandates by protecting riparian rights as opposed to prior appropriation. There are good examples of judges going against the grain and protecting riparian rights on public lands when it would produce the efficient result.2 Later into the century, even with the widespread propagation of prior appropriation across California, the riparian right was not completely forgotten. The riparian right was still the formal water right of private lands with the adoption of the English common law. By the last third of the century, the correlative reasonable use right was the primary riparian right employed, granting proportionate rights to riparian landowners and permitting marginal 2 See Irwin v. Phillips, 5 Cal 140 (1855) and Eddy v. Simpson, 3 Cal 249 (1853). Both decisions protected the riparian right on public lands. -­‐135-­‐ damages inherent in the use of the river, produced by every user and affecting every user. Apart from a few cases like Irwin and Eddy (see footnote below), prior appropriation tended to dominate on public lands, but the English common law was technically still the reigning law of private lands. In 1850 and 1862, respectively, Congress passed the Swamplands and Homestead Acts, which disposed of millions of acres of federal land to California State, which it could then disposed of to private landowners (Kanazawa, p. 169). Irrigated agriculture was the big consumer of water on these private lands. There were many individual farming operations that were protected by the riparian right of reasonable use. While California was still sparsely populated in the middle of the century, with most of the population focused around mining towns, transaction costs along rivers running through private land would have been low, in general. One of the points of reasonable use in England was to eliminate transactions, but the economic application of water, clearly, was very different in California. With greater consumption of water in California, there was a greater chance there would be a dispute between riparian users due to assertions of unequal utilization of one’s riparian right. Still, given low transaction costs, the riparian right would have been enough to induce efficient allocations of water rights through exchange because of low transaction costs. Lux v. Haggin: An Illustrative Case This is exactly what happened in the 1886 case Lux v. Haggin (Lux v. Haggin, 69 Cal 255). Haggin was an appropriator diverting water upstream from Lux on the Kern River. Though Haggin began appropriating in 1875, Lux did not decide to -­‐136-­‐ litigate until the drought of 1877-­‐79 when scarcity coupled with new diversions by the defendant caused the death of thousands of cattle owned by the plaintiff (Lux v. Haggin, 69 Cal 255). Justice McKinstry, who wrote the majority opinion, defended Lux under the rule of reasonable use. Lux had the right to equal correlative use of the river and, though minimal, incidental damages would have been acceptable, significant damages were sufficient for a suit, and thus Haggin was in the wrong. Because this was a bilateral conflict, transaction costs were low, which sent the signal that Haggin either had to discontinue his extra diversion activities or negotiate with Lux. If Haggin truly was the HVO of the water rights, he should have been able to negotiate given low transaction costs. This is exactly what happened. After Lux, the two sides got together and negotiated a mutually beneficial bargain (Kanazawa, p. 174). Essentially, Lux went to court to claim and protect his property right, and then he sold part of it to Haggin. This ruling was efficient for this case, but was it efficient for other cases involving conflicts between appropriators and riparian landowners on private lands? Justice McKinstry recognized the consequences of his decision: The contest here is between persons who, as in every other litigation, may be said indirectly to represent other persons or classes of persons having interests like those of the respective parties, since the decision in this case may establish a rule which shall determine the rights of other persons holding positions, relatively to each other, like those of the plaintiffs [supported by ranchers] and defendant [supported by farmers] herein (Lux v. Haggin, 69 Cal 255). There was the risk that, while this rule worked in this situation, it might stifle progress in the future in similar situations. All around California, there must -­‐137-­‐ have been thousands of cases like Ware’s case, where the productive uses on nonriparian land would be far greater than those on riparian lands, but where bargains might not be possible. There was the feeling that appropriative rights were necessary in order to promote greater prosperity. Indeed, it would injure riparian rights holders, but to some justices presiding over this case, it seemed neither fair nor appropriate to protect the few, being the riparians, against the prosperity of the many, or at least the soon-­‐to-­‐be many, being the appropriators diverting water to nonriparian land. This concern was voiced by all dissenting justices, perhaps most vehemently and eloquently by Justice Ross: Every practical man must know that with the dry atmosphere and porous soils of
those sections requiring irrigation, but little, if any, of the water diverted and used
in irrigation is or can be returned to the stream from which it is taken. To
establish, therefore, as the law of this state, that the water of a watercourse must
flow on in its natural channel undiminished in quantity would, in effect, be to
convert the fertile fields, gardens, orchards and vineyards in many and great
sections of the state into waste and desert places. Such a rule is inapplicable to the
condition of things existing here (Lux v. Haggin, 69 Cal 255).
Justice Ross was not alone, either. The final decision was formalized after a four-­‐
to-­‐three vote. Clearly, there was significant opposition to the majority opinion on the California Supreme Court. The dissenting justices were foreboding what was perhaps not yet a reality, but would soon become a reality: riparian rights of reasonable use were not enough to maximize the value of rivers, and with an ever-­‐expanding population, appropriation would be necessary to support people settling in the more arid regions of the state. In other words, prior appropriation would often allocate the rights to the HVOs, achieving efficiency. -­‐138-­‐ Continuing Conflict Proponents of prior appropriation and proponents of riparian rights went back and forth for the remainder of the century. In 1878 in Creighton v. Evans (Creighton v. Evans, 53 Cal 55) (in Tulare County) and in 1879 in Pope v. Kinman (Pope v. Kinman, 54 Cal 3) (San Diego County), it was decided that an appropriator could not divert water claimed by a riparian, even if no damages were imposed. If no damages were imposed, this implied that there were water rights owned by the riparian that were not being utilized. If the riparian were not utilizing these rights, it is very likely that an appropriator could have been the HVO of the rights to the water. However, the precedent set by these rulings would have deterred many new capital investments or diversions that might alter stream flows even the slightest bit, even in the absence of damages. If transaction costs to bargaining were ever too high, appropriators that were indeed the HVOs of the surplus water rights would have been deterred from bargaining to achieve the efficient allocation of the rights. Further, given the way these rulings were worded, in that an appropriator had no claim to riparian waters even if no damages were imposed, even if an appropriator could bargain with one riparian for the portion of his water rights that he was not in fact utilizing for a productive purpose, the appropriator would still be appropriating water away from a river to which other riparians had claims. The appropriator might, then, have had to bargain with these other riparians as well, given the restriction on appropriations even in the absence of damages, which could have raised transaction costs enough to deter an efficient bargain. -­‐139-­‐ That being said, with a low population and population density as of yet, transaction costs were likely still very low throughout the state. Thus, by simply endowing riparian landowners with rights to the state’s waterways on private lands, courts were setting the stage for productive bargains to take place, given that most exchanges would take place in a low transaction cost environment. Consequently, appropriators would have to prove that they were in fact the HVOs of surplus water rights through a voluntary bargain. By the 1870s and 1880s, the mining fervor had died down and many of those seeking quick riches were leaving. The counties of Tulare and San Diego in which Creighton and Pope took place, respectively, each had a population density of approximately two people per square mile (“Historical Census Populations of Counties”; “State and County QuickFacts”). With a small population, even with industrial and technological progress, where the first investment was no longer necessarily the most valuable investment, it is possible that the people were few enough that most conflicts were bilateral and could be solved through bargains with low transaction costs. Moreover, riparian land is naturally the most fertile and productive; its alluvial soils make it ideal for growing crops. This could have made many riparians the true HVOs of both their land and their water. Riparian uses also had maximum return flows from irrigation water, into the groundwater system and back into the surface water flow from which it came, and thus could support more riparians farther downstream. Alternatively, appropriations brought the water far from the stream and consumed it on nonriparian lands, which -­‐140-­‐ drastically decreased the amount of water that would make its way back through the ground and into the surface flow again to support other users downstream. Riparian uses, in this way, could have, indeed, been the most efficient and productive uses of the state’s water at the time. Yet the precedent of Creighton and Pope was reversed just a few years later in decisions favoring appropriators even on private lands. In the 1886 case Edgar v. Stevenson (Edgar v. Stevenson, 70 Cal 286), the California Supreme Court refused to enjoin the diversions of an appropriator. A riparian brought an appropriator to court for diverting water upstream from the riparian’s land, even though no damages were imposed. The assumption must have been that the precedent set by Creighton would be upheld. The Supreme Court, however, ruled in favor of the appropriator. But there was a nuance to the ruling; the court was not fully in favor of appropriators. The court only ruled for the appropriator because he had technically been diverting water only during times of surplus with heavier-­‐than-­‐usual rainfall, and thus was not injuring the riparian by diverting water when the water flow was at its “original” volume. This was a subtle ruling, but it shows some sympathy for appropriators. This decision was mirrored in the 1894 case Modoc v. Booth (Modoc v. Booth, 102 Cal 151). The judge who wrote the opinion believed that riparians should not always be allowed to restrain every nonriparian from diverting any water, simply for the purpose of undiminished, unobstructed flow: It seems clear, however, that in no case should a riparian owner be permitted to demand, as of right, the intervention of a court of equity to restrain all persons who are not riparian owners from diverting any water from the stream at points -­‐141-­‐ above him, simply because he wishes to see the stream flow by or through his land undiminished and unobstructed (Modoc v. Booth, 102 Cal 151). This case was similar to Edgar in that the court refused to enjoin the appropriator because he had only been diverting surplus, and no damages were imposed. A similar ruling occurred in 1907 in the case Cohen v. La Canada (Cohen v. La Canada, 151 Cal 680). The defendant, the appropriator, did not have his diversions enjoined because, as the court claimed, the streams he was diverting did not even flow to the streams in question running past the riparian plaintiff’s land. When an appropriator imposes no damages, it is always efficient to allocate the water rights to the appropriator. These cases reflect this understanding by the courts. A Model For Determining the Efficiency of Common Law Rulings Kanazawa (1988) offers some compelling evidence that the rulings dealing with riparian-­‐appropriator conflict might have been based primarily on transaction costs. He used an econometric analysis to show that, when transaction costs were high, the courts would use what he called a “rule of reason” that, essentially, would not require diversions by appropriators to be enjoined. He represented transaction costs with a variable called RIPARIANS that he calculated by multiplying the total number of irrigators in a county by the percentage of townships with a major river running through them, and then dividing by the total number of improved acres of farmland. In this way, he hoped to create a variable that represented as closely as possible the number of riparian landowners in a given county per acre of farmland, which he used as a -­‐142-­‐ substitute for the prevailing transaction costs along watercourses. He found that, throughout thirty-­‐two rulings in which there was a conflict between riparians and appropriators between the years of 1878 and 1910, the decisions in which the courts used a “rule of reason” had a sample mean of 8.6 RIPARIANS (8.6 riparians per thousand acres of improve farmland) and the decisions that simply upheld riparian rights had a sample mean of 2.6 RIPARIANS. All of his figures had a significance of ninety-­‐five percent or greater. What his analysis suggests is that, when there were too many riparians to bargain with, thus increasing transaction costs drastically, courts would use a “rule of reason” to allow appropriations. The assumptions are that the appropriators are the HVOs; that the courts knew this to be true; that, with low transaction costs, bargaining was assumed to be possible; and that, with high transaction costs, bargaining was assumed to be impossible. As a result, the rules used in each case differed accordingly. This is an intriguing analysis, but I do not think it fully explains all or even most of the reason why sometimes a rule of reason was used and sometimes it was not. Of the thirty-­‐two cases that Kanazawa found involving conflict between an appropriator and a riparian between 1878 and 1910, thirteen protected the appropriators’ diversions. In twelve of these, including Edgar, Modoc, and Cohen, described above, the court found that the appropriator was causing no actual damages to the riparian, and so protected the appropriator.3 Given that the 3 Boehmer v. Big Rock, 117 Cal. 19; Cohen v. La Canada, 151 Cal. 680; Edgar v. Stevenson, 70 Cal. 286; Fifield v. Spring Valley, 130 Cal. 552; Modoc v. Booth, 102 Cal. 151; Montecito v. Santa Barbara, 151 Cal. 377; Newport v. Temescal, 149 Cal. 531; Riverside v. Gage, 89 Cal. 410; San -­‐143-­‐ appropriator was causing no damages to riparian interests, it was the efficient decision to allow the appropriator to divert water because it increased the total value of production of waterways. In the thirteenth case, Wutchumna v. Pogue (Wutchumna v Pogue, 151 Cal 105), there were indeed damages to the riparian, but the riparian pleaded poorly, expressing his right as that of a prior appropriator instead of a riparian. The court found that he was second in time as an appropriator, and thus the defendant, who was an appropriator first in time, had the stronger claim to the water. The court, in fact, stated that it knew that riparians would normally be protected in this case, and cited other cases such as Lux v. Haggin to illustrate the ruling they would have handed down. But, due to poor ruling, the law protected the defendant. Thus, this case can be disregarded since the appropriator was only protected because of poor pleading on the part of the plaintiff. Disregarding Wutchumna as an anomaly, twelve out of twelve cases in which the court supported the appropriator against a riparian were only decided this way because no damages actually accrued to the riparian. This provides strong evidence that the appropriator was supported in these cases not because of low transaction costs but because the riparian interest was not even in jeopardy. Figure 1 below illustrates the eight types of rulings that could possibly occur in conflicts between riparians and appropriators when a riparian is already established along a river and an appropriator starts diverting water away to nonriparian lands. I believe that thinking about the rulings in this way is Joaquin v. Fresno Flume, 158 Cal. 626; Senior v. Anderson, 130 Cal. 290; Vernon v. Los Angeles, 106 Cal. 237; and Wutchumna v. Pogue, 151 Cal. 105. -­‐144-­‐ a much more productive way of looking at the decisions made by the California Supreme Court regarding water rights in the late nineteenth century and the first decade of the twentieth century. FIGURE 1 Low Transaction Costs •  Riparian Protected •  Damages (LRD) •  No Damages (LRND) •  Appropriator Protected •  Damages (LAD) •  No Damages (LAND) High Transaction Costs •  Riparian Protected •  Damages (HRD) •  No Damages (HRND) •  Appropriator Protected •  Damages (HAD) •  No Damages (HAND) Eight possible outcomes: (1) Low transaction costs, riparian protected, damages had accrued to the riparian (LRD). (2) Low transaction costs, riparian protected, no damages had accrued to the riparian (LRND). (3) Low transaction costs, appropriator protected, damages had accrued to the riparian (LAD). (4) Low transaction costs, appropriator protected, no damages had accrued to the riparian (LAND). (5) High transaction costs, riparian protected, damages (HRD). (6) High transaction costs, riparian protected, no damages (HRND). (7) High transaction costs, appropriator protected, damages (HAD). (8) High transaction costs, appropriator protected, no damages (HAND). LRD and LRND would be efficient no matter what. Whether or not there are damages, in a low transaction cost scenario, if the appropriator is truly the HVO, an efficient bargain can occur. If the appropriator is not the HVO, then the right stays in the hands of the riparian, the true HVO. Imagine one riparian rights holder along a river, and an appropriator begins to divert water to nonriparian -­‐145-­‐ lands. Whether or not there are damages to the riparian, if there are low transaction costs, and the riparian is protected, the efficient outcome will be achieved. If there are no damages, there is no cause to take the appropriator to court. The riparian continues his use and the appropriator adds value to the river through his use, increasing the total value produced by the water. If there are damages, or would be damages, the riparian can either proclaim his right, or go to court to have his right upheld, and then, under low transaction costs, the appropriator can bargain with the riparian for the right. If the appropriator is the HVO, he will bargain and obtain the right, achieving the efficient outcome; if he is not the HVO, he will not be able to bargain, and the true HVO, the riparian, will keep the right and achieve the efficient outcome. LAD is also efficient no matter what. Again, under conditions of low transaction costs, no matter who is initially endowed with the property right, bargaining should be easy enough and the efficient outcome should be achieved regardless. If, in the same simple example of one riparian and one appropriator, the riparian were the HVO, he could bargain with the appropriator to gain the right to the water the appropriator would otherwise divert. If the appropriator were the HVO, he would simply keep the right, and the riparian would have no way of obtaining the right. The only potential dilemmas faced by the courts are a distributional question and a question of consistency. To begin with, if the riparian begins with the right to water, and it is all of a sudden stripped from him, he will be worse off and the appropriator will be better off. This might be a worthy sacrifice if it achieves efficiency. But it would be unnecessary under -­‐146-­‐ conditions of low transaction costs. Thus, LAD is an unlikely ruling. Moreover, the courts face the conundrum of balancing consistency with efficiency at all costs. Consistency is good for rights holders because it can guarantee stability, predictability, and a certain measure of return on an investment. Under conditions of low transaction costs where bargaining can achieve the efficient outcome, it would be unnecessary and potentially contentious to adapt the rule to protect the appropriator. LAND is also efficient no matter what, regardless of transaction costs, and is the type of rule that this analysis especially focuses on. If no damages accrue, in that the riparian is not hurt, then it can only be beneficial to allow the appropriator to continue diverting water. If the appropriator were diverting water to nonriparian lands in such a way that did not affect the riparian, then it would only raise the productivity of the water in use by allowing the appropriator to go through with his diversions. It might even be useful to encourage him to continue diverting water all the way to the point at which the riparian finally begins to feel marginal damages, so as to maximize the productive output of the appropriator. Any case where no damages accrue can always be governed by “no harm, no foul.” HRD is only efficient if the riparians are the HVOs. Under conditions of high transaction costs, in which the appropriator cannot negotiate with the riparian for rights, keeping the rights in the hands of the riparian would only achieve the efficient outcome if the riparian were the HVO to begin with. If the appropriator were the HVO in an HRD scenario, it would be inefficient to keep -­‐147-­‐ the right in the hands of the riparian. The best short-­‐run move would be to reallocate the right to the appropriator in order to achieve efficiency. However, the court would again have to face the economic consequences of inconsistency mentioned above in the application of the law given the proclamation of riparian rights as the law on private lands. HRD situations in which the appropriators were actually, either individually or collectively, the HVOs was commonplace by the early twentieth century, which is why the government of California would institute a statewide reallocation of rights to water from riparians to appropriators. This led into the modern administrative era of California water law. HAND, like LAND, is efficient no matter what. If no damages accrue to the riparian, then the appropriator should be free to continue his diversions. His productive use of the water, in addition to the riparian’s use of the water, increases the productive value of the water and achieves the efficient outcome. It would be unwise to deter the appropriator in this type of situation. HAD is only efficient if the appropriator is the HVO. Like in the case of HRD or HRND, given high transaction costs, in order to achieve the efficient outcome the individual initially endowed with the property right must be the HVO, because bargaining is impossible. In the case that an appropriator is diverting water that is damaging a riparian, it would only serve efficiency to protect the appropriator with the right to continue his diversions if he were the HVO of that water. Let us assume that Kanazawa’s procedure for determining transaction -­‐148-­‐ costs is reasonably accurate and representative of the prevailing transaction costs at the time each of these cases were decided. Recall that he found that all the cases where the appropriator was protected had high transaction costs relative to the cases in which the riparians were protected. This means that all twelve cases where appropriators were protected were HAND cases: high transaction costs, the appropriators were protected, and, as I have pointed out, no damages had accrued. But as I also just pointed out, with no damages, protecting the appropriator would be efficient regardless of the prevailing transaction costs. Whether high or low transaction costs accompanied these cases was irrelevant. All that mattered was that riparians were not being injured, which made the appropriator the HVO. In fact, in many of these cases, the justice writing the opinion of the court was careful to point out that, normally, riparians would be protected from an adverse appropriator, but were just as careful to highlight that there were no damages to the interest of the riparian party. It made efficiency sense, then, to protect the appropriator. So what does this say about Kanazawa’s analysis? For one, it means that it is somewhat irrelevant. As is clear, regardless of whether these cases were decided amidst low or high transaction costs conditions, protecting the appropriator was efficient when no damages had accrued. In all twelve cases, no damages had accrued to a riparian. The interesting question is: if Kanazawa’s characterization of transaction costs was accurate, is it just coincidence, then, that there just happened to also be high transaction costs in situations of no damages? It could be coincidence. But there are other possibilities. A large -­‐149-­‐ number of riparians could have meant a greater abundance of water, which might make it more likely that an appropriator could divert water without injuring a riparian. One might also turn this assertion on its head. There could have been a large number of riparians for other reasons, such as the attractiveness of the climate, and, given that many of these cases took place in the generally more arid southern region of the state, there might have, in fact, been less water than the state average. In the face of water scarcity, the Supreme Court could have been protecting appropriators out of the necessity to expand the allocation of water. Indeed, in many of these cases, the criterion used by the justices writing the opinions to illustrate a lack of damages to the riparian plaintiff was either: (1) that the appropriator’s diversion was, indeed, diminishing the water flow but it was shown that the riparian did not need that water for their operations; or (2) that the riparian was claiming damages to their agricultural interest but it was shown that most or all of their land was unfit for cultivation anyway. If this were the case, then the court was adapting to the prevailing conditions and deciding in favor of efficiency. Kanazawa might also have simply been wrong in his characterization of transaction costs. In many of the cases where appropriators were protected, there could have in fact been low transaction costs. Maybe there were still a lot of irrigators, but many of these irrigators could have been appropriators themselves, whereas Kanazawa characterized them as riparians. In fact, this would make more sense in the arid southern region of the state where it would often be necessary to irrigate on nonriparian land given the paucity of rivers and -­‐150-­‐ streams. In which case, transaction costs along rivers might have been few with far fewer riparians than Kanazawa asserted. This would turn some of the HAND cases into LAND cases, which are still efficient, because protecting the appropriator when no damages have accrued is efficient no matter what. CONCLUSION What all of this analysis means is that the Supreme Court of California was adapting to the prevailing conditions toward the objective of promoting economic growth for efficiency defined in terms of total productive value. From the dawn of gold mining in California up until the birth of the modern era of California water rights in 1913, the courts, the government, and the people of California have shown their commitment to efficiency, and their ability to adapt to different or changing conditions in order to maximize efficiency. The original squatters proved their ability to construct informal legal structures strengthened by community norms and procedures, in order to extract the most value from scarce water sources. While these original squatters claimed riparian rights, it soon became clear that, in order to continue extracting value from California’s gold mines, a new water right was necessary. The mining regions of California were the first places that prior appropriation was officially applied in the United States, setting a precedent for all other western states to follow. Allowing miners to portion out the water, measure it, and divert it to nonriparian land allowed miners to continue extracting value from gold mines through the use of California’s surface water while placer deposits in stream beds were running out. -­‐151-­‐ On private lands, the riparian right of reasonable use maintained dominance officially. For a short while, California adopted the no-­‐injury principle and quickly transitioned into a correlative reasonable use doctrine. While the adoption of the riparian right might have been as much a mistake as a conscious decision, there were good reasons, at first, to believe that riparians might have been the HVOs of the water. Given the productivity of riparian soil as well as the maximum return flows from riparian lands back into the surface water flow for others to use downstream, it is certainly possible that riparian applications of water on private lands produced the most value. Regardless, transaction costs were low enough early in the state’s formal history that, even if riparians were not always the HVOs, new users or appropriators hoping to divert water away from riparian lands could bargain easily enough with riparian rights holders in order to reallocate water rights to the HVOs and achieve the efficient outcome. Specifically, when appropriators were causing no harm to riparians, it would always be the efficient choice to let them continue their activities rather than to enjoin their operations given the increase in productivity, and thus an increase in the value in use of the water. As the population grew, however, and rivers naturally experienced an increase in population density, transaction costs would grow. Perhaps more importantly was the fact that increasing populations meant a greater number of people with uses for water on nonriparian lands, given California’s lack of waterways and low annual rainfall. It became increasingly clear that prior appropriation would become the reigning water rights rule for California’s surface water, although this formal transition was not seen until -­‐152-­‐ 1913. This transition, and the subsequent history of California’s modern era of water law, is discussed in Chapter 4. -­‐153-­‐ Chapter 4 INTRODUCTION In Chapters 2 and 3, I showed how both the early English common law of water rights and the early California common law of water rights evolved over time to match the prevailing economic conditions and transaction costs in order to induce the efficient allocation of water rights. The English common law evolved from strict private property rights under the ancient use doctrine, which were subsequently reallocated to reflect the newly presumed highest-­‐valuing owners (HVOs) under the first occupancy doctrine, to a more common-­‐resource riparian right of reasonable use. Each subsequent transformation of the governance structure fit appropriately with the transaction costs along waterways as well as the dominant uses of the water in order that water rights would end up in the hands of their HVOs in order to maximize the productivity of England’s waters in a time of economic growth and industrialization. The California common law applied water rights in more of a differential manner, upholding the riparian right of reasonable use at times and on other occasions protecting appropriators in water rights disputes. California courts applied the law in this way because different circumstances called for different rulings in order to achieve the efficient allocation of water rights. -­‐154-­‐ I now turn to the modern era of California water rights, that of the early twentieth century through to the present. I seek to show how four major characteristics and tools of the modern era of water rights has allowed the State of California to allocate water rights as efficiently as possible in the face of growing pressure on this precious natural resource. First, the riparian right of reasonable use, while it still exists, has taken a back seat to the right of prior appropriation. The appropriative right is the dominant form of water rights in California, allowing this state of few surface water streams to divert water widely across the state to support a burgeoning economy and population. Appropriative rights are still adjudicated, at times, by the courts, but they are now allocated by a central state board, called the State Water Resources Control Board, which also has immense authority in the matter of water rights adjudication and transfer of those rights, as I will show. Second, the amendment to the California Constitution, entitled Article X, Section 2, is a very useful tool in the effort to allocate water rights to their HVOs. The state has a lot of power in this respect, which might give many free market environmentalists a severe headache, but I will show that the government’s application of this amendment is very useful in achieving efficiency. Rather than argue that Article X, Section 2 is a perfect governing tool, I will try to argue that its use represents the best alternative among imperfect alternatives. Third, the public trust doctrine, which compels the government to utilize its police power to protect waterways in the interest of public values in recreation, wildlife, ecosystem, natural resources, fishing, and navigation, is -­‐155-­‐ another useful tool that helps California achieve efficiency in water rights allocation. In similar fashion to Article X, Section 2, the public trust doctrine would cause many free market advocates to shake their heads. However, it is important that the government apply this doctrine at times to represent the values protected by the trust in order to, in effect, allocate water rights to the California public when the public is the collective HVO of the water rights. This includes situations where the individuals comprising the public who value the public trust would otherwise fail to negotiate a collective, productive bargain with a water rights holder proposing to damage the public trust. Lastly, the transfer provision of the California Water Code constructs the transfer approval procedure in such a way that maximizes the assurance that the water rights subject to transfer will end up in the hands of their HVOs. Transfers of water rights can indirectly affect the water rights of individuals not party to the transfer. The procedure to have transfers approved, therefore, has been erected so as to force the parties to a transfer to prove their status as the HVO by engaging in bargains with all water rights holders that may be indirectly damaged by the transfer. Through the analysis in this chapter, I hope to show, just as I have in Chapters 2 and 3, that the water laws of California evolved appropriately as new conditions and transaction costs emerged so as to reveal the HVOs of water rights most effectively and encourage the efficient allocation of water rights in this state of scarce water. -­‐156-­‐ THE IMPORTANCE OF ADMINISTRATIVE OVERSIGHT OF WATER RIGHTS The Appropriative Water Right Justice Erskine Ross, the Supreme Court justice who offered a forceful dissent in Lux v. Haggin in 1886, was somewhat prophetic in his vision. Recall that he thought that maintaining the almost exclusive rights of riparians to use waterways would turn much of the state into “waste and desert places.” While much of the state is not, in fact, waste and desert, it might have been had water law not changed. But it did change. California’s population increased by sixty percent between 1900 and 1910, by forty-­‐four percent between 1910 and 1920, and by sixty-­‐six percent between 1920 and 1930 (“Historical Census Populations of Counties”). The California legislature must have seen this coming in the first decade of the century. Almost every county in the state began to see spikes in their population in that first decade, with some, like Alameda County, almost doubling. In order to support these people, and to foster economic progress, large quantities of water were needed in areas far removed from riparian lands. The end of the century also saw a large increase in the number of water cases tried and increasing complexity in the details of each case. Moreover, it was quite likely that water rights conflicts would only get worse, given ever-­‐
expanding populations, increased energy needs, and powerful industrial progress. In order to get the most out of California’s water, to quell conflict, and to deliver consistent adjudicative results, it made sense to divide up the state’s water resources into micro-­‐volumes and allocate rights according to use needs. This division of the state’s water is exactly what the appropriative right was able -­‐157-­‐ to accomplish. Recall that an appropriative right grants a permit to an individual water rights holder to a specified volume of water annually that the rights holder may then divert for a specified purpose off riparian lands. It is important to detail the permitting process for appropriative rights in order to understand how the board ensures that a new appropriative right does not illegally injure any water rights holders (“The Water Rights Process: The Permit Process”). First, an individual must file an application with the SWRCB, describing the water source, the place of use, the project purpose, the point of diversion, and the quantity to be diverted. The SWRCB requires that all potential conflicts be resolved before a new permit is approved. This includes the possible environmental impacts of new diversions, the implications for the public trust, and all other water rights holders whose rights may be infringed upon by the new appropriative right. In order to determine public trust and environmental impacts, the SWRCB conducts detailed investigations with expert assistance and testimony, ultimately preparing a thorough Environmental Impact Report. In order to determine that no other water rights holders will be injured, public notice of the applicant’s intent is posted. Copies of all protests and comments filed by concerned parties, including potentially injured water rights holders, are given to the applicant to resolve. No new appropriative permit can legally injure existing water rights. Thus, if the applicant can resolve conflicts with protesting parties through voluntary negotiations, then the applicant is assumed to be the HVO of the water rights for which he is applying, and approving the application will allocate the water rights efficiently. -­‐158-­‐ If the applicant fails to resolve conflicts, one of two things happens. First, the application might be denied in the assumption that the applicant is not the HVO. Second, if the SWRCB has reason to think the applicant might be the HVO, but that negotiation difficulties with one party, including large transaction costs, may have impeded successful negotiations, the SWRCB may solve the issue through an engineering field investigation report by the Division of Water Rights branch of the SWRCB. The report might still result in a denial of the application, or it may approve the application if it is deemed that either no damages would accrue to other water rights holders or that damages would be minimal and that the applicant would produce the most value as the HVO. This type of administrative intrusion only occurs for small water projects, presumably because the damages are much more easily discerned through an engineering field investigation in case conflicts cannot be resolved. The permitting process, thus, has intense procedural requirements in order to ensure that the SWRCB allocates the proposed water rights permit to the HVO. Allowing and encouraging affected water rights holders to file protests allows the true value of the water rights to emerge through voluntary negotiations between the applicant and the protestors. In the case that voluntary negotiations fail for small projects, the SWRCB might submit an investigative engineering report that determines the costs and benefits of small diversions where such costs and benefits are easily determined. The permit is then denied or approved on the basis of whether the applicant emerges as the HVO. This ensures that the efficient allocation of water rights is achieved. -­‐159-­‐ Imagine the alternatives to this volumetric permitting process for appropriative water rights. There are two main alternatives to the centralized permitting and regulatory system currently in place: (1) govern all surface water under riparian rights, either of reasonable use, first occupancy, or rights based on volumetric permits; or (2) govern surface water under a decentralized system of appropriative permitting and regulatory statute formulation, leaving administration up to towns, counties, and/or regions. In the next subsection, I will go through these alternatives, show how the alternative rule would work, and then compare this rule with the administrative permitting process. The Alternatives Reasonable Use To begin with, the riparian right of reasonable use would be quite unproductive. To reiterate, reasonable use is the rule that all users along the same waterway share the water equally, both in times of plenty and times of drought. Each user has a right to water volumes proportionate to the extent of their riparian land along the river. Only significant transgressions causing damages to other riparians grants an injunction. At the time when centralized administration was taking over in the early twentieth century, the whole country, especially California, was experiencing expansive growth in population. If the reasonable use rule were to reign, it would be very difficult to allocate water as productively as possible. For one, given the paucity of waterways in California, only a small fraction of the population could settle along the rivers and streams of the state, prohibiting all others from direct access to the state’s waters. This, in itself, is a -­‐160-­‐ problem. But, for a moment, forget the rest of the citizens of California that cannot settle along the waterways – there were already problems among those riparian landowners along the streams. There will always be uses of water in California that will require more than just the equal correlative right granted to all landowners under the riparian reasonable use rule. Imagine that one landowner realizes she could expand the operations of her agricultural production fruitfully, and that it would be profitable to buy up many plots of land upstream and downstream, in order to gain the rights to the water of the previous owners. Once again, the holdouts become a problem. It is in the best interest, at least in the short run, for every other riparian upstream and downstream that she tries to negotiate with to holdout for a greater payment. As Calabresi and Melamed pointed out (Calabresi, p. 1106-­‐1108), these holdouts each individually will want to get their hands on some or all of the surplus that the farmer would gain through the entire set of negotiations. Thus, they will hold out from negotiations to try to get more from the deal. Overcoming this obstacle will be costly and time-­‐consuming for the farmer, and it might ultimately render her aspirations implausible. The transactions costs will likely be overwhelming, blocking the movement of rights from lower-­‐ to higher-­‐valuing owners and leaving rights inefficiently allocated. Indeed, the courts could employ a liability rule. They would have to determine the fair market price at which to compensate the owners of each plot of land. In the case of the farmer above, in order to overcome the transaction costs associated with the holdouts, a liability rule would compensate the victims -­‐161-­‐ of the takings fairly and eliminate the necessity of a transaction and its associated costs. This would not necessarily be too difficult if the farmer planned only to negotiate with ten to twenty other riparians, perhaps even a few more tens of owners. But say the farmer already has a successful business, and knows she can expand greatly and still profitably. This might increase the number of riparians the farmer wants to buy land from to hundreds, perhaps even thousands, of individuals. The task of determining the fair market price for thousands of individuals will either be beyond the reach of the courts, or simply so time-­‐consuming that the court loses some of its own productivity, seeing far fewer cases in general, as well as water cases. Certainly, with economic growth, the acquisition of more water from other riparians would constantly be necessary, and the courts would constantly be trying to apply a liability rule to many of them due to large numbers of transactions producing large transaction costs. This would deter many transactions and would also limit the effectiveness and efficiency of the judicial system. To limit the transaction costs of applying the liability rule, the court might decide to apply a flat rate to all landowners. But this is not a great alternative, given that so many landowners would be greatly undercompensated or overcompensated, surely not the ideal scenario. Abstracting once more to focus on the greater issue, perhaps the worst part about reasonable use as an alternative is that, regardless of the struggles faced by riparians alone, the rule of reasonable use would effectively exclude everyone else in the state living on nonriparian lands from accessing the water in the scarce waterways, leaving them to soak up the little rain that falls over the -­‐162-­‐ state. The picture becomes much more daunting when one considers all these millions of individuals. The first solution that comes to mind is that any one of those entrepreneurial individuals buying up riparian land could become a private water supplier. This is already entering appropriative territory. There would have to be some appropriative right structure to govern these types of activities. Imagine that an appropriative right came into existence, and that there were hundreds of users like the farmer described above who recognized a very large market unutilized on nonriparian lands. Much like the farmer, they could conceivably buy up thousands of riparian water rights and serve as a distributor. Remember, though, the obstacles from above. Even if they could overcome those obstacles, and gained an appropriative right to sell water diverted from streams, they would have to invest in massive and extremely expensive piping, delivery systems, and water treatment structures and facilities. There would also likely be tens, perhaps hundreds, of other entrepreneurs trying to enter the market. If this type of service was subject to the conditions of market competition, it is likely that there would be many different water provision projects with overlapping piping systems, and every time a customer left one distributor to subscribe to another, this next distributor would have to build a new piping extension to the customer’s house, and the first distributor would have no incentive to extract their own pipe from the ground. It would be a physical, environmental, and logistical nightmare. The most efficient result would be to have one centralized system that provided water everywhere. These firms would be better off to combine all of their operations. -­‐163-­‐ This type of consolidation could happen through mergers to form one giant monopoly over appropriative water rights, either in private hands or in the hands of the government. A strictly private monopoly always has the incentive to allocate its resources in a profit-­‐maximizing way that might restrict access to many consumers. But unlike other goods, water is a necessary condition for life. One cannot be restricted by the price system through monopoly power from access to water and survive, whereas restricted access to artisan cupcakes does not result in death, at least for most. For this and other reasons to be discussed further below, I will argue that it is better that the power to allocate appropriative rights to water should remain in the hands of a government monopoly as opposed to a private monopoly. This is essentially what has happened, as well. The government currently has a tree-­‐like distribution system that provides water to customers through a piping system with branches that get smaller and smaller as they approach individual customers at their point of use. Moreover, a distribution system like this would require incredible capital investment and coordination, which the state has undertaken and controls. So, given the value of having an appropriative system, someone has to determine who gets what and how much. Given the scarcity of water in California, anyone seeking to earn an appropriative right would certainly try to gain a permit to more water than they actually need in order to have some leeway during times of drought. The courts would have a lot of trouble allocating fair appropriative rights to all the productive users desiring permits. They simply would not have the manpower or the knowledge to deal with the great -­‐164-­‐ number of individuals who need water. There could be some kind of private third party that could allocate permits to appropriators. But all third parties are subject to the threat of rent-­‐seeking. Indeed, the individuals that make up the government are subject as private individuals to these dangers. The case of Owens Valley in the early twentieth century is a great example. As mayor of Los Angeles and superintendent of the Los Angeles Department of Water and Power (LADWP), respectively, Frederick Eaton and William Mulholland used underhanded methods to allocate water rights in a way that benefitted them on a purely individual basis. The US Bureau of Reclamation had been planning to build an irrigation system in the Owens Valley to assist the Owens Valley farmers, where the water rights were initially endowed. Instead, Eaton and Mulholland bought these rights from Owens Valley farmers before the Bureau would intervene. They misled the public and far underestimated the potential for water development in Los Angeles, thus keeping land prices in the surrounding area low as well as water rights prices from Owens Valley farmers relatively low. Eaton and Mulholland, with the help of investors, then bought up cheap land in the San Fernando Valley north of the city and, keeping their plans secret, arranged a transfer of water from the Owens Valley to the San Fernando Valley. This would skyrocket the price of the San Fernando lands because they could now be cultivated extensively, which made Eaton, Mulholland, and their investor friends a large profit. A purely private third party is subject to the same pressures, as well, with its own board and a single CEO and investors with eyes on the bottom line. If, in -­‐165-­‐ the case of the Owens Valley Transfer, the right to allocate water were in the hands of a private party, I would not be surprised if this private party engaged in similarly underhanded tactics to turn a profit. The fact is, the world is full of risks, everywhere; nothing is perfect. In any situation, the proper governance structure is never entirely obvious, and any governance structure will have its imperfections and pitfalls. It is, therefore, not the goal to choose the perfect governance structure, but rather to choose the governance structure that performs a certain function better than the other possible governance structures; the least bad of all the bad alternatives. It is unlikely, I think, that every single member on the board of the SWRCB and those on the boards of all of its member and regional agencies would be rent-­‐seekers. Even just one member on one of these boards could expose rent-­‐seeking plans. Information technology and greater scientific knowledge would make it much easier nowadays for anyone to verify the truth of claims made by someone like Eaton or Mulholland. Scientific and economic claims will be checked by numerous other experts in the field and argued out. Moreover, since their jobs do not depend on pleasing investors and maximizing profits, those working for a government agency are not beholden to making the most money, and can govern more equitably. While private rent-­‐seeking on the part of public officials is still certainly possible and undoubtedly occurs, I think it is less likely to occur through the California water boards than through a private enterprise claiming to be allocating water objectively towards the efficient use. -­‐166-­‐ Decentralized System of Appropriative Permitting The second major alternative to the centralized system that currently reigns is a decentralized system of regional permitting and statute formulation. This would be an unproductive way to govern water. Because of water’s nature, its transient quality, one river, or one stream, can flow for hundreds of miles. Anyone upstream in a different region who increases or decreases their allocation, or who begins a new water development project, or who pollutes the water at all, will be affecting everyone downstream, including all those users that would be out of the jurisdiction of that regional office. As a result, these regional offices would have to talk to each other, build a relationship, and coordinate and cooperate their allocation and regulatory efforts no matter what. Joining all of these regional offices and agencies under one governmental structure can help increase productivity through streamlined rulemaking, increased cooperation and coordination, and allow the legislature and the SWRCB to help coordinate these operations and the regulations enacted, to encourage relevant research and development, and to establish statewide agendas. Water, after all, is a statewide resource that affects everyone, is necessary for everyone, and produces chains of causation through the actions of any water user. Much like the entire United States, there are certain agendas that are handed down through the federal government, to the entire nation, that each state of which must then follow while still maintaining a measure of independence to capitalize on local expertise and differing regional needs. Certainly the needs of upstate California, with higher than average rainfall, will -­‐167-­‐ be different in some ways than the needs of southern California. This is why regional offices exist, so as to utilize their local expertise, to establish regulations that are unique to their region and climate, as well as to find the best way for that region to comply with statewide and federal regulations. This unified and coordinated effort is the best for the management of water in this water scarce state. Again, this type of consolidation could happen between private firms, all merging to aggregate their allocation duties into one massive enterprise. A top-­‐
down agenda with collaborative efforts to maintain California’s water resources and to allocate them as efficiently as possible, given differential regional conditions and needs, is absolutely a possibility. Simply too much is at stake when it comes to water, however. Water must be allocated to every domestic citizen for day-­‐to-­‐day use, if nothing else. I worry about the dangers of private monopoly over our precious water resources. I do not think the government is perfect, but I think it can more effectively govern appropriative rights to water in California given all of the various demands placed on water, and the necessary appurtenant amenities to water use, such as dams and reservoirs. ARTICLE X, SECTION 2 One of the most influential pieces of legislature affecting water rights passed in California was the constitutional amendment of 1928 called Article X, Section 2 (“California Constitution, Article X Water”) (hereafter referred to as Article X). This amendment did one massively significant thing: it subjected all surface water rights to reasonable and beneficial use. This was not the same thing as the -­‐168-­‐ riparian doctrine of reasonable use. Article X’s reasonable use referred, literally, to whether the government declared the use to be reasonable or not, as opposed to the equal correlative right of the riparian reasonable use doctrine. The amendment states that the use of water in streams “shall be limited to such water as shall be reasonably required for the beneficial use to be served, and such right does not and shall not extend to the waste or unreasonable use or unreasonable method of use or unreasonable method of diversion of water. Riparian rights in a stream or water course attach to, but to no more than so much of the flow thereof as may be required or used consistently with this section, for the purposes for which such lands are, or may be made adaptable, in view of such reasonable and beneficial uses” (“California Constitution, Article X Water”). Essentially, what this allowed the state to do was to take away rights from people who were not using their water reasonably or beneficially, and the definition of “reasonable” and “beneficial” was left almost entirely to the state and the courts interpreting the law, granting them great power. In the manner in which the law was applied throughout the twentieth century, if a water rights holder were to have his water use deemed unreasonable by the state, he would be faced with two alternatives: either a taking would occur, or the wasteful user could otherwise engage in conservation practices and then transfer the previously wasted water to another productive source. For instance, as a farmer, if I am utilizing my water rights for irrigation farming, but my practices are outdated and significant volumes of water are lost due to my inefficient practices, the state might deem my use unreasonable if -­‐169-­‐ there is another use that will use the water more efficiently and productively. I am left with two alternatives. I can either submit, and the state will take my water rights and reallocate them, or I can invest in conservation measures and then transfer my excess water rights to another productive use. This second provision, the conservation and transfer provision, of Article X had two important effects: one, it allowed the use to remain in use, thus not simply taking away the business of the water rights holder; and, two, it encouraged the transfer of unused water to more productive uses, increasing overall productivity. Otherwise, those in charge of wasteful practices might hide from authorities for fear of losing all of their water to the state under Article X. The conservation and transfer provision of Article X allowed wasteful users to come out from hiding, admit to their wasteful practices, and actually gain in the long-­‐run by engaging in conservation, requiring less water, and selling their surplus for a profit to another user. Everyone was better off as a result of these transfers, and an increase in the productivity of California’s water was achieved. This will be discussed more in the section on transfers, as well as in the case between the State Water Resources Control Board and the Imperial Irrigation District below. Joslin v. MMWD: Takings and Reallocations of Water Rights The first influential case to look at is the Supreme Court of California case Joslin v. Marin Municipal Water District (MMWD) (Joslin v. Marin Municipal Water District, 67 Cal 2d 132), where the taking aspect of Article X was applied very clearly. The Joslin family had been supporting a rock, sand, and gravel business -­‐170-­‐ utilizing their riparian rights as riparian landowners along the Nicasio Creek in Marin County, collecting chunks of earth that flowed down the river by their property and selling them. In 1962, the MMWD constructed a dam one mile upstream from the Joslins’ land, catching the rock and gravel and destroying the Joslin business. Marin was one of the fastest growing parts of the Bay Area during the decades following World War II; MMWD built the dam to support this growth. In making their decision, the Supreme Court of California looked to Article X for guidance. What they declared, under this amendment, was that the Joslins’ use of the water was not a reasonable use. The majority opinion referred to Article X, stating “what is a reasonable use or method of use of water is a question of fact to be determined according to the circumstances in each particular case” (Joslin, p. 139). Essentially, the Court believed that, while the Joslin family’s use of the water was reasonable before, given the growing domestic demand in Marin County, the MMWD’s dam was a far more reasonable use. Indeed, the Joslin family’s use was beneficial, but it was exceedingly less important in light of public interest, that being the efficient use of California’s scarce water resources, than was the construction of the dam. As the Court put it: “Is it ‘reasonable,’ then, that the riches of our streams, which we are charged with conserving in the great public interest, are to be dissipated in the amassing of mere sand and gravel which for aught that appears subserves no public policy? We cannot deem such a use to be in accord with the constitutional mandate that our limited water resources be put only to those beneficial uses ‘to the fullest extent of which they are capable,’ that ‘waste or unreasonable use’ be prevented, and that conservation be exercised ‘in the interest of the people and for the public welfare’” (Joslin, p. 140-­‐141). The family’s use of the water might have been reasonable at first, but given new -­‐171-­‐ demands on water, it quickly became “unreasonable,” according to the Court’s interpretation of Article X, for them to use the water in this way as compared to new potential uses, such as the water district’s construction of a dam for municipal purposes. Given the way the law was worded and applied, if someone was declared to be using water unreasonably, they were not having their right taken away; rather, it was treated as if their right simply no longer existed. It existed only so long as the use was reasonable, but as soon as the use was unreasonable, the right no longer existed. “From the foregoing we arrive at the conclusion that since there was and is no property right in an unreasonable use there has been no taking or damaging of property by the deprivation of such use and, accordingly, the deprivation is not compensable” (Joslin, p. 145). As a result, according to the takings clause of the US Constitution, the state would not have to compensate for these takings. This, again, gave the state massive power in determining where water would be allocated for the sake of efficiency. The idea was that the state was in the best position to determine how the water could be used most productively. In the case of Joslin v. MMWD, reallocating the water to MMWD was certainly the most efficient allocation, as opposed to protecting the family rock and gravel business. Indeed, Article X also had large consequences for distributional welfare. Article X at this time was essentially a constitutional liability rule, where the liability was zero dollars; a taking without compensation. The Joslin family challenged the assertion of the Court that no compensation was due, but to no -­‐172-­‐ avail. The Supreme Court ruled in favor of the defendant, the MMWD, and required no compensation to be paid. Assuming the government does a good job of determining that the current use is not the highest valued use, the lack of compensation seems to be a secondary effect that has no consequence for efficiency, but it certainly does for distribution. Indeed, distributional concerns are important to people, and it seems justified to compensate people for these takings. Perhaps, in a state like California that craves more water, it was not high on anyone’s list to start talking about compensation if it was not legally required. Joslin’s lawyer made a convincing argument that was ultimately shot down by the Supreme Court: “Section 1245 of the California Water Code imposes liability upon municipal entities for damages caused by a municipal water supply project to any ‘property, business, trade, profession or occupation’… The Joslin court decided that since Joslin had no protectable property right…there was no statutory liability for damage to his business” (Dunning, p. 3, note 10). Essentially, Section 1245 simply did not apply to this case, because as soon as the state determined that the Joslins’ use of the Nicasio Creek was unreasonable, the Court treated the case not as if the Joslin family had their right taken away, but rather that their right never truly existed. This seems to me to be an unjust and unreasonable ruling. If the MMWD’s use of the water was truly so valuable, so much more valuable, in fact, than the Joslin family’s use of the water, then surely the MMWD could have easily compensated the Joslin family for their losses. Indeed, it was claimed that “the value of the plaintiffs’ land was thereby diminished in the amount of $250,000, -­‐173-­‐ and that plaintiffs had been deprived of gravel and rock having an accrued value of $25,000 at the time of filing the complaint” (Joslin, p. 135). This is no small loss in value, even if it may be slightly overvalued. I believe this ruling is not only unjust and lacking in compassion, but it is also an abuse of state power. Even granted that it might truly be in the interest of efficiency to give the state monopoly power over the allocation of water rights, this does not relieve the state of its duty to also act fairly. Public takings of private rights demand compensation according to the US Constitution. If the state truly is so effective at allocating rights efficiently, then every time it reallocates a water right to a more productive use of the state’s water, there will be enough monetary benefit to fully compensate the victim of the taking. Instead of being a liability rule with zero compensation, Article X would be a much better law if it reclaimed the taking aspect of its true nature and became a liability rule with just compensation. Still, regardless of whether this taking without compensation was just or not, it did achieve the efficient result. Allocating any property right efficiently is not affected by the welfare distribution consequences of the allocation, or reallocation as it may be. In Joslin, the Joslin family lost an abundance of money as a result of the taking, while the MMWD made an abundance of money. This caused a large shift in the relative welfare distribution of this localized case, but the efficient result was still achieved. The highest-­‐valuing owner (HVO) was the MMWD, with all its domestic consumers, and the allocation of the property right to that use was the efficient allocation. Thus, again, regardless of whether or not -­‐174-­‐ the taker is required to compensate the victim of the taking, these takings are productive. This type of uncertainty, where one’s use could be deemed unreasonable at any time, is not the greatest condition to operate under. Indeed, as was seen in Chapter 3, California has been dealing with water scarcity for a century and a half and the people of the state have always believed in using their scarce water as efficiently as possible. Under conditions of extreme scarcity and great population growth, it seems there is not much sympathy for unproductive uses of water. Still, I believe that the interpretation of Article X could have favored compensation just as easily as it ultimately favored no compensation. The ultimate interpretation was therefore unjust and, interestingly enough, completely unnecessary to achieve the stated goal of allocating in the public interest, that of efficiency. Efficiency is unaffected by distributional welfare and still would have been achieved even after the compensation of the Joslin family. An additional point worth consideration is that, even though the Joslin family lost the right to the water, they did not really need the physical water, they only needed the rocks and gravel that naturally flowed to their land. They were essentially paying nothing, as riparians, for the main input in their family business. It is entirely conceivable that they could have worked out an agreement with the county, after the trial, to pay a sum of money for the right to extract the rocks and gravel that would build up at the point where the dam was built. After all, the dam was only a mile upstream from the Joslins’ land. It seems there was a mutually beneficial bargain somewhere in that ruling, given that the county did not need the rocks and gravel, which, if anything, would only have -­‐175-­‐ been a nuisance once they piled up so high at the dam that they interfered with other operations. It could be seen that this decision simply separated two types of rights: rights to water and rights to the gravel. The Joslin family only needed the gravel, and a beneficial bargain could have certainly taken place. However, I think this would be a weak and naive interpretation of the decision. Firstly, the Joslin family was a riparian landowner protected by riparian rights. The interpretation of Article X was an abuse by the state in its police power, and resulted in the complete destruction of a private business unnecessarily. Secondly, this ruling set a strong precedent for subsequent rulings to refer back to. All future cases would surely not involve similar facts such that this interpretation of Article X would merely distinguish two types of rights, those to water and those to some other natural resource appurtenant to the water flow. While the Supreme Court may have decided unjustly in Joslin, at the turn of the new millennium, courts were mandating compensation, despite the historical tendency to not require compensation under the takings clause of the US Constitution. Two cases illuminate this change: Tulare Lake Basin Storage District (TLBSD) v. United States (2001) and Casitas Municipal Water District (CMWD) v. United States (2008) (Lund, p. 320). The former case, in the US Court of Federal Claims, involved a taking of water by the US government from TLBSD due to restrictions on the State Water Project (SWP) under the Endangered Species Act, causing shortages for some SWP contractors. During the time of Joslin’s case, these shortages might have been deemed incidental to regulation, and thus unreasonable uses anyway. Compensation would not have been -­‐176-­‐ required as the right to the water would have been lost. In this case, however, compensation was due; this court went against the precedent of the Joslin court’s interpretation of Article X and required the US government to pay the contractors about $26 million in compensation. Likewise, in CMWD v. US, also in the US Court of Federal Claims, there was a taking of water from CMWD resulting from stipulations required under the Endangered Species Act. Once again, the precedent of the Joslin court was reversed, and the government was made to compensate the victims of the taking. While this represents a change in the stance on compensation due to takings on behalf of the government for public use, it made no difference for efficiency. The public value embodied by the Endangered Species Act still existed, and it was still within the government’s reach to compensate the victim, thus maintaining a productivity increase. Compensation was inconsequential for efficiency, but it had a profound effect on distribution, one that many would say was just, including myself. A different distribution was served than that served in Joslin. The victims of the takings were ultimately much better off than the Joslin family because they had been fairly compensated for their losses. Still, whether or not the victim was compensated, the right to the water was allocated to the HVO and the efficient outcome was achieved. Should the Government Be Involved At All? The important question to ask in all of this is whether or not the government should be involved at all. Is the application of Article X necessary, and does it achieve efficiency as effectively as possible? Should the government involve itself -­‐177-­‐ in the reallocation of water rights as opposed to leaving such reallocations to voluntary bargains? I believe the answer depends. When a transfer is possible, the government should forego involvement, and when a transfer is impossible, the government should get involved. The government should involve itself, then, when transaction costs to bargaining are too high. Article X works well in cases where transaction costs would be too high for beneficial negotiations to take place. Imagine that a farmer holds the appropriative water rights to some volume of California’s waters, and that his water right produces moderate value in use. There are likely thousands, if not millions, of other individuals around California that have dreamed up a productive application of water, but lack a water right. If even one of those individuals could put the farmer’s water rights to use and produce more value than the farmer currently produces, it would be efficient for the farmer to sell that individual his water rights. In the case where transaction costs are low, the government has no reason to get involved though the utilization of Article X. With low transaction costs, a voluntary bargain can occur whereby the HVO can buy the water rights from the farmer. However, in the case where the transaction costs of bargaining are too high for the farmer to negotiate with the HVO to move the water right to the highest-­‐valued use, Article X would be useful. For instance, perhaps the HVO and the farmer live in different counties and find it difficult to communicate effectively, or maybe the HVO has to pay multiple additional parties, such as lawyers and economic or scientific experts, to help determine the conditions of -­‐178-­‐ the case and the valuations of the rights at issue. In the case that these transaction costs are too large to overcome, Article X can deem the lower-­‐valued use an unreasonable use and transfer the right into the hands of the HVO. To reiterate, regardless of whether or not compensation is legally due, if the new use truly produces greater value than the sum of the losses sustained as a result of the reallocation of the water right, then efficiency is achieved. Nonetheless, this would not be, in my opinion, a satisfactory result. The government could easily reinterpret Article X as requiring compensation and, instead, utilize this amendment as a liability rule in order to ensure the victim of the taking is at least partially compensated at what is deemed the fair market price. Certainly, the government does not have the capacity to monitor all possible transfers and always find those potential transfers where transaction costs would be too high and forcefully reallocate the water rights at question, even if a liability rule with due compensation were employed. The government could, however, limit its choice of potential transfer events in which to apply Article X to those in which there would be great benefits. One might assert that, if there are indeed great benefits, then even moderate transaction costs should not deter such a transaction. This is not necessarily the case. In situations involving either many benefitting individuals or many potential sellers, or both, there is the potential for costs associated with free riders and holdouts. In California, where there are millions of citizens and likely hundreds of thousands of water rights holders, transactions involving many parties are highly possible. As I have discussed previously, free riders to a transaction on the buyer -­‐179-­‐ side will piggyback on the contributions of other benefitting individuals in order to minimize their own costs and maximize their own benefits. The problem is that all benefitting individuals have the incentive to free ride. On the other side of the transaction, holdouts, recognizing that the buyers will profit from the transaction, will hold out from the transaction until other sellers have sold their rights in order to sell their own rights at a much higher price to get a greater piece of the buyers’ profits. Similarly, all sellers have the incentive to holdout. Organizing all of these individuals and persuading them to desist from their holdout and free rider activities in order to successfully complete an efficient bargain might produce large enough transaction costs to render the transaction impossible. Article X, as a liability rule, could deem the seller’s uses unreasonable given the circumstances, those being the existence of a much higher-­‐valued use, and reallocate the rights to the buyers by imposing a flat rate that all sellers would have to accept for water rights on a per volume basis. This would systematically undercompensate and overcompensate many individuals, but it would still achieve the efficient outcome, and at least many individuals would be at least partially compensated with some even overcompensated. The government could also try to estimate the value of the water rights to each seller and impose differential liability rules for each seller. This would cost a lot, but if it cost less than the transaction costs associated with free riders and holdouts, and it also produced fewer transaction costs than there were profits from the transaction, then this type of liability rule would also be efficient, and would -­‐180-­‐ better serve distributional welfare. As long as Article X is used only when a voluntary market exchange could not naturally occur, then the government will not be overextending its own usefulness. It is important to note that, without Article X, cases in which transaction costs would be too high for voluntary transactions to occur would still exist. With the existence of Article X, at least some major transactions that would otherwise be deterred might come to fruition. It seems Article X was misused, however, in Joslin. To begin with, I would find it difficult to believe that transaction costs in that bilateral conflict would have been so high that they would have deterred a mutually beneficial and efficient bargain. Even in the event transaction costs were too high, Article X was still misused and should have required compensation. IID v. SWRCB: Conservation and Transfer It is clear that Article X has utility, especially when transaction costs are not possible through voluntary bargains. However, the real utility of Article X, in my opinion, is not in its application as a liability rule, but rather in its application to cases where a water rights holder is clearly engaged in wasteful and inefficient practices. Article X claims that, when water rights holders are wasting water, in that they own the rights to water that they are not putting to a productive use, either through wasteful practices or simple neglect of excess water rights, their use of this water is unreasonable. However, as I alluded to earlier, there is an important provision of Article X that allows wasteful users to invest in conservation measures and to then sell their excess water rights to the HVOs. -­‐181-­‐ This addresses inefficient uses of water that would otherwise not be addressed. While one might believe that a water rights holder who is wasting water would always seek to sell their excess water to the HVO to make more money and to achieve efficiency, this does not always happen. For whatever reason, some users will simply sit on their excess rights, or perhaps they are not even aware that they are wasting water. This next case is an illustrative example of this application of Article X. The California Court of Appeal case Imperial Irrigation District (IID) v. State Water Resources Control Board (SWRCB) in 1986 (Imperial Irrigation District v. State Water Resources Control Board, 186 Cal App 3d 1160) is a great example of how the conservation and transfer aspect of Article X can be applied to achieve efficiency. In 1983, John Elmore, a farmer, petitioned the Division of Water Rights (DWR) to investigate the “alleged misuse of water by IID in the form of losses due to canal spills and excess tailwater running from the fields of IID’s customers” (IID, p. 1163). The DWR concluded that the IID was, indeed, wasting water and using it unreasonably, according to Article X, referring the matter to the SWRCB. The SWRCB, in Water Rights Decision 1600, declared IID’s use to be unreasonable under Article X, forcing IID to engage in conservation measures and granting them the right to transfer their excess water after conservation. Essentially, the IID had their water rights to what was deemed wasted water officially stripped from them, but they had the opportunity to sell them rather than lose them without compensation. At first, in 1984, in anticipation of having to comply with these conservation measures, the IID -­‐182-­‐ began to engage in negotiations with the Metropolitan Water District (MWD), a consortium of twenty-­‐six cities and counties in Southern California, drafting an agreement to transfer to MWD tens of thousands of acre-­‐feet of water annually (afa) in exchange for millions of dollars in payments to support delivery and irrigation system improvements that would meet the reasonable use requirement. Negotiations were eventually cut off because of disagreements over contract stipulations and prices. As a result, with no negotiations lined up to comply with the conservation requirements handed down by the Board, IID challenged the Board’s declaration, stating that the Board did not have the statutory authority to declare the use unreasonable. In an attempt to repeal the conservation requirements, IID went to court defending the claim that the Board did not possess the power it claimed to possess. The trial court ruled in favor of IID. However, the Board sought further review and had their appeal granted by the court of appeal. The court of appeal reversed the trial court’s decision, ultimately defending the Board, reaffirming the Board’s right to “all-­‐encompassing adjudicatory authority” under Section 275 of the California Constitution (Grey, p. 270). After citing numerous comparable cases, including Supreme Court cases, where the Board’s authority under Article X was upheld, the court of appeal questioned the trial court’s judgment: “In light of these constitutional, statutory and Supreme Court authorities which apparently establish all-­‐encompassing adjudicatory authority in the Board on matters of water resources management, how could the trial court have found an absence of such authority in the matter of unreasonable -­‐183-­‐ water use under article X, section 2?” (IID, p. 1169). This decision necessitated that IID reengage in negotiations with MWD. This time, MWD was in a position of greater power given the court of appeal’s recent ruling and were able to negotiate more productively. IID was legally obligated to conserve water, so it could not threaten to forego negotiations with MWD. In 1988, the SWRCB issued a follow-­‐up order directing IID to conserve 100,000 afa by 1994. By the end of 1988, IID had come to an agreement with MWD to transfer to them 106,100 afa for thirty-­‐five years in exchange for $98 million over ten years for conservation programs. The application of Article X to cases like this allowed the state to identify wasteful practices and induce conservation and reallocation of previously wasted water to other beneficial uses, increasing the total value in use of the water. Without Article X, IID certainly would not have conducted fruitful negotiations with MWD any time soon. They only entered into negotiations with MWD initially because the Board had demanded that they conserve water under Article X. Even then, they were incapable of coming to contract terms that both sides could agree upon, and they instead went to court in an attempt to reverse the Board’s decision. The fact that the IID would rather have gone to court than to conserve water is strong evidence that, without Article X, the IID would not have, any time in the near future, voluntarily invested in conservation practices and then initiated negotiations with MWD. There are certainly many other water users, like IID, that would rather forego investments in conservation and voluntary transfers than actively pursue such measures. They would rather -­‐184-­‐ cover up or neglect their wasteful practices, either for fear of admitting to wasteful practices or in resistance to investments they deem unnecessary. This conservation and transfer provision of Article X, alternatively, encourages just the opposite. Water rights holders who are wasting water, if they have not already been caught by the Board and forced to conserve and transfer, will have the incentive to assess their waste and to engage in beneficial conservation and transfer agreements voluntarily, before the Board steps in. Clearly, there was ultimately a productive negotiation to be had with MWD. Water was conserved, and the excess was transferred, increasing the overall value in use of the water. An efficient outcome was achieved as a result of the influence of Article X that likely would have otherwise not occurred or occurred only years after the fact. The existence and application of Article X induces productive transfers of water in situations where, even with low enough transaction costs, a voluntary bargain might not have occurred. Perhaps IID was not aware that farmers it was supplying were engaged in wasteful practices, or perhaps MWD was not aware that it could buy some of IID’s excess water. This is an example of imperfect information, something that can inhibit potentially productive bargains from being realized. The existence of Article X, however, capitalizes on mutual monitoring of the actions of water rights holders, where the aggregated knowledge and information held by all water rights holders can help bring about productive bargains. John Elmore is a great example of this, recognizing water wastage on the part of IID that many people were unaware of. Without John Elmore, MWD might never have known they could benefit from -­‐185-­‐ some of IID’s water and increase efficiency in the allocation of the water rights. John Elmore was empowered by Article X to speak out. This amendment, I believe, is one of the great drivers of efficiency in modern California water law. The application of Article X to IID can be seen as the imposition of a quasi-­‐
liability rule. IID’s wasteful water practices had been identified, so it was clear that this excess water could be reallocated to a more beneficial use than that of waste. IID’s rights to this wasted, excess water were then deemed unreasonable and taken from them. The district was, thus, forced to conserve a large volume of water in order to match its remaining reasonable water rights with the water it was consuming. However, rather than reallocate the water rights to a source of its choosing without compensation, as it had done in Joslin, the Board allowed IID, under the transfer provision of Article X, to transfer the water rights it had lost to another source in a transfer agreement. Through this transfer agreement, IID, effectively, would be compensated. Article X was still a liability rule, essentially, except that the government left the transfer of the rights up to the victim of the taking rather than declaring itself where the water rights would go. The freedom to choose with whom IID wanted to transfer the rights would hopefully allow the true HVO to emerge through the market, rather than through a government mandate. Indeed, in a truly voluntary bargain, IID would probably have demanded greater profits through negotiations, but liability rules do not guarantee profits, only fair compensation. The modern era of water law, as illustrated above, is marked by the reallocation of water to higher-­‐valued uses. In order to continue to meet rising -­‐186-­‐ demand, California could, up until the 1980s, develop new water sources, building new dams and reservoirs. But, in the 1960s, water development began to atrophy. Dams filled up most of the state’s rivers and streams, and the state’s water was almost entirely appropriated. This is partly why Article X is so important for the reallocation of highly scarce water to more productive uses. By the 1980s, new water development was impossible (Grey, p. 259), so all existing water had to be subject to reallocation in order to see productivity increases, either through the market or as subject to Article X. But the modern era of California water law is also marked by another, relatively recent development. State waters are now protected to a great extent under the public trust doctrine, providing for the maintenance of instream flows for uses such as navigation, recreation, fishing, wildlife, and salinity management. THE PUBLIC TRUST DOCTRINE AND ENVIRONMENTAL REGULATION The public trust doctrine is more than one hundred years old, originally upheld to require that a certain level of stream flows be left unappropriated for the purpose of navigation, fishing, and recreation. It could be applied through regulation or through court cases. While it was never a huge factor in water management, it has been utilized much more intensively recently, having been extended to include wildlife and ecosystem protection as well as salinity management. With growing populations, greater effects on the global environment due to advances in technology and modes of production, and a subsequent increase in environmental consciousness, greater value has been placed on the environment mainly over the last half-­‐century. The environmental -­‐187-­‐ movement gained significant momentum in the 1970s, pressing for serious consideration of the effects of human water use on wildlife and the ecosystem, endangered species, and the long-­‐term sustainability of our own use of water, given the dangers of salt intrusion into fresh waters, damages to nutrient cycling through the ecosystem, and erosion of soil from dry stream beds. Examples of environmental regulation include the California Environmental Quality Act of 1970, which required environmental reviews prior to further development of water projects, and required that all projects include damage mitigation measures. The California Wild and Scenic Rivers Act of 1972 placed the north coast of California off-­‐limits to new appropriations. The federal government also began to regulate to protect a national interest in the environment. The 1972 Federal Water Pollution Control Act Amendments, also known as the Clean Water Act, spurred the SWRCB to conduct environmental evaluations of two of the major California water projects: the Central Valley Project (CVP), which delivers seven million afa on average to agricultural, urban, and wildlife uses, five million afa of which goes to farms, feeding about one third of the agricultural land in California (“Central Valley Project”); and the State Water Project (SWP), which delivers three million afa on average to urban and agricultural water suppliers in Northern California, the San Francisco Bay Area, the San Joaquin Valley, the Central Coast, and Southern California (“About DWR – State Water Project”). In 1992, President Bush signed the CVP Improvement Act, requiring the Bureau of Reclamation to manage 800,000 afa of the CVP for restoration purposes for fish, wildlife, and habitat, permitting the use of some of -­‐188-­‐ this water to assist in the Bay-­‐Delta Estuary management. In 1993, the National Marine Fisheries Service (NMFS) issued a Biological Opinion for the Operation of the CVP and SWP, recommending a reduction in pumping of water from the Delta during salmon immigrating months. This was necessary to comply with the Endangered Species Act and the CVP Improvement Act (Grey, p. 252). I point to these examples to stress the new recognition and greater consideration of environmental values, both in California as well as nationwide. National Audubon Society v. Superior Court: The Public Trust in Action In order to get a sense of the utility of environmental regulation that serves the public trust doctrine, it is useful to consult a case in which the public trust doctrine is protected. An instrumental case in the California Supreme Court that affirmed the relevance of the new environmental regulation was National Audubon Society (NAS) v. Superior Court (National Audubon Society v. Superior Court, 33 Cal. 3d 419) in 1983. The Los Angeles Department of Water and Power (DWP) had been appropriating water since 1940 from streams feeding Mono Lake in Mono County on the eastern central border of the state. They increased their diversions in 1970 to 100,000 afa, almost the entire flow of the streams. By 1979, the supplies equaled about twenty percent of all water available to Los Angeles. The NAS challenged the rights of the DWP on the grounds that they were violating the public trust doctrine. They reported that salinity levels in Mono Lake had increased drastically, species were going extinct, which was threatening the food chain, land bridges were forming allowing predators to -­‐189-­‐ cross the lake and destroy the habitat of nesting birds, and 18,000 acres of very fine silt was exposed, which was going airborne in winds with a high concentration of alkali and other minerals that irritate humans and other animals (Grey, p. 264). Furthermore, NAS claimed that, in fifty years from the time of the trial, putting its projection at about 2030, the lake would hold less than twenty percent of its natural volume. NAS feared, additionally, that “the lake will not stabilize at [twenty percent of its natural volume]” but “may continue to reduce in size until it is dried up” (NAS, p. 429). When water is over-­‐
appropriated, it can cause erosion and ecological decay, harming the surrounding wildlife. River ecosystem health is necessary for nutrient cycling, soil formation, helping also to regulate floods, the climate, disease, and water purification (Forslund, p. 11). All of these are significant sources of value for humans. In light of the circumstances, and the scientific evidence presented, the Court reaffirmed the duty of the state to protect the public trust doctrine against the harmful diversion activities of DWP: “the state’s authority as sovereign to exercise a continuous supervision and control over the navigable waters of the state and the lands underlying those waters” (NAS p. 425). The state has the authority to regulate the uses of any water rights holder in order to leave a large enough, and clean enough, volume of water in a surface water source to sustain the uses protected under the public trust doctrine. The court made an important clarifying point about the public trust doctrine: “The prosperity and habitability of much of this state requires the diversion of great quantities of water from its stream for purposes unconnected to any -­‐190-­‐ navigation, commerce, fishing, recreation, or ecological use relating to the source stream. The state must have power to grant [appropriative] rights to appropriate water even if diversions harm public trust uses. Approval of such diversion without considering public trust values, however, may result in needless destruction of those values. Accordingly, we believe that before state courts and agencies approve water diversions, they should consider… the public trust, and attempt, so far as feasible, to avoid or minimize any harm to those interests” (NAS, p. 426). They did not have to protect to public trust against all other uses, because necessary uses will clearly clash with the public trust at times, but it was important to keep it in mind and preserve uses protected by the trust whenever possible. The court, in fact, discussed the integration of the appropriative right and the public trust doctrine in California water law, explaining that the two were not one entity, nor were they mutually exclusive. The public trust interest the state must protect, however, allows for the reconsideration of previously granted appropriative rights in the face of new interests. “The objective of the public trust has evolved in tandem with the changing public perception of the values and uses of waterways” (NAS, p. 434). Given the renewed recognition of great public trust value in Mono Lake, at the time, a reconsideration of the public trust interest in Mono Lake was justified. “The water law of California – which we conceive to be an integration including both the public trust doctrine and the board-­‐administered appropriative rights system – permits such a reconsideration; the values underlying that integration require it” (NAS, p. 426). Reaffirming the state’s power to regulate water use in the name of the public trust allowed the state to modify the extent to which DWP was allowed to appropriate water from the streams feeding Mono Lake. This power was used to protect the public trust. -­‐191-­‐ Adherence to the public trust doctrine in this case did one very important, very simple thing: it protected the uses under the doctrine, “the human and environmental uses of Mono Lake, uses protected by the public trust doctrine,” uses that “deserve to be taken into account” (NAS, p. 452). The general existence of the public trust, and its active application to cases such as this one, is a very useful tool. Until now, in discussing this case, I have yet to mention efficiency. However, the public trust doctrine is essential for efficiency. In a hypothetical State of California, devoid of the public trust doctrine, environmental values would still exist. There would still be individuals around the state who would value Mono Lake for its aesthetic beauty, for the healthy ecosystem of which it is an integral part, and for the navigational, recreational, fishing, and commercial uses to which it is put. In a State of California without the public trust doctrine, however, it would be difficult for all of these individuals who place value in a healthy Mono Lake ecosystem for its different uses to organize a bargain with DWP to cut back on its diversion activities. Such a bargain is the market alternative to the application of the public trust doctrine by the state. Imagine that, instead of the state regulating DWP’s diversions of Mono Lake, all those individuals who valued Mono Lake in a healthy ecological state would have to bargain with DWP for a portion of its water rights. The transaction costs that would likely inhibit such a transaction are those that I have been reiterating throughout this paper. There are the typical transaction costs of organization all of the involved parties, paying lawyer’s and court fees, -­‐192-­‐ determining the benefits and costs to all parties, and then actually negotiating and coming to some agreement. On top of that, there would be free rider problems. All those individuals who would benefit from such a negotiation would have the incentive to free rider on the efforts of others. This type of free riding would be intensified by the fact that some individuals would value conservation more than others, perhaps far more. Those who valued it less would free ride on the contributions of those who valued it more, and those who valued it more would likely predict this type of behavior on the part of those who valued it less and, as a result, lower their own contributions so as not to carry as much of the burden. Even if all parties involved would ultimately be able to find a volume decrease in diversions that would maximize, or come to close to maximizing, the efficiency of the transaction, the transaction costs that it would take to get to that point would likely be insurmountable. Additionally, even in the event that a market transaction would have been able to foster this result, which I believe to be highly unlikely, there will continue to be cases in which the values protected under the public trust will be threatened. It cannot be true that, in all of these potential cases, market transactions will successfully foster the efficient result. There will always be cases where transaction costs are too large for individuals to voluntarily engage in negotiations and achieve an efficient transfer of rights. This brings me to why the application of the public trust doctrine is essential for achieving efficient results in cases like NAS. The public trust doctrine essentially gives voice to public values in the state’s waters that would -­‐193-­‐ otherwise go unheard. The Supreme Court of California in NAS talked a lot about the importance of the public trust in protecting the public interest. The invigoration of the environmental movement in the 1960s and 1970s that sparked the first comprehensive environmental regulations across the nation sent a strong message to the state that the public interest was shifting in a powerful way. The people of the US, including California, wanted the public trust protected more than ever before. When the Supreme Court of California reaffirmed the state’s power to protect the public trust given the prevailing public interest in NAS, it empowered the state to moderate DWP’s diversions in the name of the public interest reflected in the intense environmental values now obvious and prevalent nationwide. By protecting this interest, it protected great amounts of value held by the citizens of California, as well as the entire United States, in the assumption that the aggregate of this value was greater than the value that could be produced in use through appropriations by DWP. In essence, protecting the public trust allocated the water rights to the perceived HVOs, the public at large, achieving the efficient allocation. The state is not perfect in making determinations, but I believe the court made the right decision to uphold the state’s power to decrease appropriations in the case of Mono Lake in the name of the public trust. It was because of the public trust doctrine that, not only was the state empowered to make this decision, but it was also compelled to make this decision. Once the state had its right reaffirmed, it certainly could have judged wrong, and the additional appropriations acquired by DWP could have, in fact, produced greater value in -­‐194-­‐ use than the value produced through the protection of the public trust. However, I believe the state judged correctly, given that the potential damages over the long-­‐term were so catastrophic that the reduction in value protected by the public trust would be so great that it would overwhelm DWP’s benefits. The state enforced the efficient allocation of rights, and the public trust doctrine allowed it to do so in a circumstance where voluntary exchange would have failed. Moreover, reconsidering NAS, even if a voluntary bargain were achieved, it would be achieved at the expense of tremendous transaction costs. Applying the public trust doctrine can achieve the same efficient allocation of the rights without the expense of transaction costs. The Public Trust Doctrine and Distributional Welfare It is worth at least briefly discussing the distributional implications of the public trust doctrine as well. In NAS, DWP already had the appropriative rights to almost all of the waters feeding Mono Lake but only decided to divert fifty percent of the stream flows initially in 1940. When DWP increased its diversion to include almost the entirety of all the stream flows feeding Mono Lake, it was initially lawfully allowed to do so. It was only after the application of the public trust doctrine that DWP lost the right to divert as much as it desired. Under any comparable circumstances, in which a private actor has been endowed with a right in the past, but police power of the state allows it to reconsider this right and to reallocate it to another use, the victim of the taking should be compensated, which the public trust doctrine requires. Just like the Joslin family should have been compensated, so should any victim of a direct taking under the -­‐195-­‐ public trust doctrine. Indeed, if the public trust value is so valuable, then the state should be able to compensate the victims of its takings with taxpayer money. After all, it is the taxpayers who are being represented by the public trust doctrine. Just because it is too difficult for these taxpayers to arrange their own bargain with the water rights holder does not justify zero contributions to the taking of the rights. Indeed, as I pointed to earlier, the government is not perfect at making valuations, and is subject to mistakes when judging the benefits to the members of society it is representing under the public trust doctrine compared with the costs to the victims of the taking. Richard Epstein eloquently describes the usefulness of compulsory compensation under the public trust doctrine: The point of the system is that if the state can afford to pay the compensation for the losses that it imposes upon private owners, then there is good reason to believe that the entire set of coerced takings will benefit all (or virtually all) members of society simultaneously… If takings could be made by state fiat alone, then, to avoid abuse, there would necessarily have to be elaborate administrative reviews to estimate, first, the value to the state of the property taken, and second, the losses the taking imposes upon the private owner… These investigations would be expensive to supervise, and in the end there would be little reason to have any confidence that only the “right” takings were undertaken by the state. The requirement of just compensation thus serves as an effective bulwark against government abuse by making public officials back up speech with dollars (Epstein, p. 418). However, the public trust doctrine is not only applied in the reconsideration of existing rights, but it can also preempt the endowment of future rights. When the state determines, with extensive scientific and other third-­‐party testimony, that a certain volume of water must be maintained in surface waters of the state in order to protect the public trust, compensation is not required for future losers. They have not yet obtained and lost a water right to that water and they never will so long as the mandates set forth remain. As -­‐196-­‐ long as a right has not been taken, compensation is not required. This seems contradictory to the insight of Epstein about compulsory compensation, in that it allows a certain measure of guarantee that the efficient allocation of the water rights is truly achieved. Without such compensation, the state is subject to the very complications of administrative valuation that Epstein pointed to. However, I believe that, while the state may not actively pursue such a valuation because of its inherent complications and difficulties, on aggregate, state application of the public trust doctrine will produce more benefit than harm. Indeed, its application may sometimes fail, as no system of governance is perfect. But in understanding that no system of governance is perfect, I believe that the application of the public trust doctrine by the state would still be more successful in achieving the efficient allocation of property rights than the market alternative, due to the market inefficiencies I described above. The state is not incompetent, and, as evidenced by a lengthy majority opinion in NAS detailing the extensive consideration of value inherent in the various uses of Mono Lake, I believe the state is capable of reasonably assessing the benefits of applying the public trust doctrine case by case with the help of the scientific and economic expertise it employs. It is not a “best world” scenario, but it is the least of the bad scenarios. A Final Thought I would like to make one additional point about the public trust doctrine and the market alternatives. We cannot wait for private firms, in the absence of voluntary bargains, to moderate their own environmentally destructive -­‐197-­‐ behavior. Examples abound of private firms not internalizing environmental damages as an input to production. Additionally, many people think that, once faced with potential catastrophe, human ingenuity will pave the way to a brighter future. But innovation takes time. “Entrepreneurs scrounge for capital, investors struggle to manage the risks of emerging technologies, patents get bought and sold but not necessarily used… There isn’t time to sit and wait years for great innovations to wend their way toward everyday use” (Rau, p. 3). In the same way, we cannot wait to see what destruction lies in the future for us, and hope that our technology will save us. When private firms do not account for the significant damages they can cause due to environmental negligence, they can promote inefficiencies in production. For the same reason that it would have been difficult in the case of Mono Lake for a mass of individuals, all of whom value Mono Lake for its various uses protected under the public trust, to negotiate a voluntary bargain for water rights from DWP, it would similarly be difficult in any comparable situation for the general public to negotiate with any environmentally negligent firm. This is the reason for state action on the part of environmental values in the first place. Just as citizens who value minimal pollution are allocated the right to be free from pollution by environmental regulations, so are the values of the public trust doctrine protected by its application in cases like NAS. The public trust doctrine requires the government to moderate private uses of California’s waters in order to protect public values when the public cannot protect these values alone, achieving the efficient allocation of water rights where voluntary bargains would fail, or where private -­‐198-­‐ firms would fail to internalize their environmental costs. THE IMPORTANCE OF TRANSFERS The obvious logic behind transfers is the same logic that is behind any bargain: through transfers, water rights holders in California should be able to reallocate water to its highest-­‐valued use whenever possible and whenever new uses spring up. This is in line with the goal of maximizing the total value of California’s waters, and this logic was not lost on lawmakers or the courts. Through conservation and transfer, Article X was able to force transfers through a quasi-­‐liability rule to higher-­‐valued uses that otherwise would not have occurred through voluntary market negotiations. But transfers took on many other forms. In order to comply with environmental regulations mandating certain levels of stream flow, water rights holders not in compliance can buy water rights through a transfer from a lower-­‐valuing owner (LVO) in order to comply with those regulations. Transfers of water rights can also be simple transfers from LVOs to HVOs that achieve efficiency and increased productivity that have nothing to do with either Article X or compliance. Transfers of water rights are governed by Chapter 10.5 of the California Water Code (“Statutory Water Rights Law,” Chapter 10.5, p. 92-­‐97). Short-­‐term transfers of less than one year and long-­‐term transfers of greater than one year are subject to essentially the exact same requirements. First, any water rights holder who would like to transfer his water rights to another individual must petition to the Division of Water Rights branch of the SWRCB. The Division of Water Rights (DWR) then acts as a third-­‐party to negotiations in order to help -­‐199-­‐ guarantee that the transfer “would not injure any legal user of the water, and would not unreasonably affect fish, wildlife, or other instream beneficial uses” (“Statutory Water Rights Law,” p. 92). The petitioner is required to provide the DWR extensive information, and various procedures are required for the petition to be approved, most importantly: “Reference to the permit or license that serves as a basis for the water transfer”; “a written description of the changes in water storage, timing, and point of diversion, place and purpose of use, timing and point of return flow, and water quality of instream flows that are likely to occur”; “provide a copy of the petition to the Department of Fish and Game”; “publish in not less than one newspaper of general circulation…a notice of the petition… The board shall…provide to the petitioner a list of water rights holders of record on file with the board who may be affected by the transfer, and the petitioner shall provide written notice to those water right holders not later than 10 days after the date on which the petition is submitted”; “within 10 days of the date of receipt of the petition, the board shall commence an investigation of the proposed…change” in order to assist in the verification of the information presented to the board by the petitioner; “water users that may be affected by a proposed…change and any other interested party may file a written comment regarding a petition with the board”; “the board shall render a decision on the petition not later than 35 days after the date that investigation commenced or the date that the notice was published, whichever is later” (“Statutory Water Rights Law,” p. 92-­‐3). There are a few summary aspects of the petition procedure to take away from the Water Code. First, there is doubling and tripling up on efforts to verify the facts of the transfer and the relevant effects on other water rights holders as well as values protected by the public trust. Second, any water rights holder that may be affected by this transfer is allowed to file a protest, and any other individual or party is allowed to file comments, including the Department of Fish and Game (DFG) or any other party interested in speaking for the public trust, all of which are reviewed by the DWR as well as the petitioner. Third, the petitioner must resolve all protests, guaranteeing that no other water rights holder is injured involuntarily and -­‐200-­‐ that the public trust is sufficiently maintained, or else the DWR will deny the petition to transfer water rights. What this transfer procedure seeks to guarantee is that there are no inefficient transfers granted by the DWR. Any time water rights are transferred, or the way water is allocated, acquired, or stored changes, there is the potential for indirect damages to other water rights holders not party to the actual transfer negotiations. In other words, there will be third-­‐party damages as a result of any direct transfer between two parties. As Epstein made clear, no administrative body will be able to estimate these damages perfectly. Therefore, it is no one’s expectation that the DWR, when it reviews all the facts of the transfer, will be able to perfectly determine the damages to other water rights holders as a third-­‐party arbitrator. However, they are only one among four general groups that are seeking to determine these damages, serving as a supplementary source of knowledge rather than a central planner determining all costs and benefits unilaterally. Those groups are the petitioners, the DWR, the damaged water rights holders themselves, and any organization or party, such as the DFG, seeking to protect the public trust or any other interest. The damaged water rights holders themselves probably have the best idea about the damages that will accrue, but it can only help to have many other experienced eyes assessing the petition as well. Any water rights holder, as well as any other individual claiming to have a stake in the transfer, may file protests or comments after the petition is posted. This aspect of the procedure capitalizes on the strengths of free market -­‐201-­‐ exchange. Instead of cutting out those affected and granting the DWR strict authority to determine damages, this procedure directly involves those who would be affected, mandating that their protests be resolved through a voluntary bargain with the petitioners before approving the petition. If their protests cannot be resolved, the assumption is that the damaged individuals are the HVOs of the water rights at question, and thus the efficient result is to deny the transfer. If the protests can be resolved, the assumption is that the petitioner is the HVO of the water right, and thus the efficient result is to approve the transfer. MID and USBR: The Transfer Petition Procedure I will use an example to illustrate just how this procedure ensures that the efficient outcome is achieved. On December 16, 2011, Merced Irrigation District (MID) filed a petition with the DWR for a long-­‐term transfer of 90,000 afa of water from the Lake McClure reservoir to the US Bureau of Reclamation (USBR) (“Merced Irrigation District”). The USBR would then release water from the New Melones Reservoir, which it operated, into the San Joaquin River. USBR is required to meet water quality and fish and wildlife enhancement objectives for the San Joaquin River as part of the 1995 Bay-­‐Delta Plan. This transfer of water and subsequent increases in releases from the New Melones would help USBR achieve these objectives. MID had typically held a certain level of water in storage in the Lake McClure reservoir, and the details of the transfer would possibly reduce that quantity of water and/or change the timing of releases from the reservoir. A notice of the petition was published a few days after the petition -­‐202-­‐ was filed, the DFG was notified by the petitioner, and any legal water rights holder who may have been affected by the transfer was allowed to file protests and comments. Two water rights holders, the Stockton East Water District (SEWD) and Douglas N. Brower, filed protests. SEWD was a water district receiving water from the New Melones Reservoir operated by USBR. SEWD protested because of a concern that USBR would not always be able to supply SEWD with the full volume of water to which it legally held the water rights when USBR would periodically release greater quantities of water from the New Melones to meet the Bay-­‐Delta Plan objectives for the San Joaquin River. SEWD demanded that releases from the Lake McClure reservoir into the New Melones Reservoir, as part of the transfer agreement between MID and USBR, be timed so as to maintain water levels in the New Melones Reservoir in order to meet all demands from water rights holders supplied by USBR through that reservoir, including SEWD. In a way, SEWD spoke for itself as well as all other downstream water rights holders supplied water by USBR that may have had their rights negatively impacted by the stipulations of the transfer agreement. MID agreed to SEWD’s demands, resolving the protest. Douglas N. Brower ultimately withdrew his protest after discussions with MID in which MID was able to persuade Brower that he would not be injured. Various parties seeking to voice their opinions about potential damages to the public trust and to add their suggestions also filed comments. These comments were taken into account and influenced the final transfer agreement. No significant damages to the environment or the public trust were found. In fact, it -­‐203-­‐ was emphasized that the purpose of the agreement was, in fact, to help USBR better meet the objectives of environmental regulation and the public trust. Because all protests were resolved voluntarily by MID and those who protested, and because no significant damages to the environment or the public trust were found, the petition was approved by DWR. I believe this representative example of the transfer procedure provides strong evidence that the current transfer procedure is very effective at ensuring that water rights are allocated efficiently. The fact that the DWR, a government agency, is an active third-­‐party arbitrator present in all water rights transfers would certainly concern many free market advocates and others who doubt the government’s ability to effectively oversee a transfer and determine the efficient allocation of rights. However, when it comes to the actual transfer stipulations and determinations of costs and benefits, the DWR plays more of a supplementary, guiding role rather than a central planner acting unilaterally. It conducts its own investigations into the costs and benefits of the transfer, but only to provide additional information. All legal water rights holders damaged by the transfer are the ones who are actually involved in negotiations with the petitioner. The DWR simply keeps track of and documents comments and protests raised by affected parties. It then adjudicates in much the same way a court would by upholding the rights of legal water rights holders. The only way, then, for the petitioner to have his transfer approved by the DWR, acting in the same capacity as a court, is to conduct voluntary bargains with those who are damaged. This requires compensation of those individuals, which allows the true HVO to -­‐204-­‐ emerge. If the petitioner cannot compensate damaged water rights holders, then he is not the true HVO, and the transfer will be denied. If the petitioner can compensate damaged water rights holders and come to an agreement, then he is the true HVO, and the transfer will, and should, be approved. The market is generally best at surfacing the true costs and benefits of certain actions. California Water Code transfer law capitalizes on this reality and is therefore highly effective in allowing the total value in water use to be maximized through the efficient allocation of water rights. As Charles Meyer and Richard Posner wrote in a report to the National Water Commission in 1971: When criteria of allocation other than willingness to pay are used, it is very difficult to decide which uses (or users) of a resource would be most productive. To answer administratively such questions as whether a piece of land would be more valuable as a site of an apartment building or a shopping center is extraordinarily expensive and time-­‐consuming. In contrast, the price system produces an unambiguous and usually quite satisfactory answer. The party in whose hands the property will be most productive is the party who values it most highly and is accordingly willing to pay the most for it. (Grey, p. 277). Posner and Meyers are right in that the market can produce incredible results if it is utilized properly. Indeed, the beauty of these voluntary bargains between the relevant water rights holders is that it keeps the determination of costs and benefits in the hands of the party that knows them best, that being the parties subject to negotiations, rather than in the hands of an imperfect central planner. The DWR hands down a final approval or denial of transfers, in the same way a court might, but it does not take upon itself the task of unilaterally determining whether a transfer will achieve the efficient allocation of water rights. Instead, the Water Code is written so as to grant the DWR arbitration and law enforcement duties, but the actual bargaining process takes place between -­‐205-­‐ affected parties, in which the true costs and benefits surface through free exchange. Two Final Provisions of Transfer Law Two final and important pieces of transfer law are the Emergency Drought Water Bank (EDWB), created in 1991, and the right of first refusal. First, the EDWB is useful because it allows water rights holders to voluntarily transfer water, in payment for their water, to this drought bank where it is then stored and redistributed later by the state in times of scarcity and drought. This is helpful because it adds an extra incentive to conserve water and increase the productivity of one’s water use. It also increases the security of California water in times of drought and great scarcity, which can allow the state to smooth out the productive value of water instead of subjecting the people of California to sudden troughs in productivity due to the forces of nature. For instance, imagine a wasteful water user who chose to continue wasting water, in that some of the water to which the user held a water right would not be put to a productive use, instead of conserving and transferring their water to the drought bank. Then, in times of water scarcity, there would be no drought water fund to supplement the decrease in water supply, and the wasteful user would be far less productive in this scarce state of nature. Alternatively, conserving and transferring water to the Emergency Drought bank in payment for the water allows future users threatened by a period of drought to retrieve some of the water they have stored in their “savings account.” This can help them to maintain to a greater ability their productive capacity for that drought year without sacrificing productivity -­‐206-­‐ during the year in which they decided to transfer water to the bank (i.e. to save for the future). This is a very useful function organized by the state to maintain productivity levels with the state’s scarce water supply. Moreover, building one’s own storage facility or reservoir privately is not something the majority of the less-­‐than-­‐super wealthy can accomplish. It is much easier to declare a conservation level for one year and to have the government, already in charge of all aspects of transfer and allocation statewide, to store the conserved water for that year and then allocate water during times of drought. Second, when a transfer is proposed in a given water basin, the “right of first refusal” allows anyone in the vicinity of the transferring party a ninety-­‐day period to purchase the soon-­‐to-­‐be transferred water under the exact same contract conditions, but they also have to compensate the parties to negotiations for the costs associated with the development and negotiation of the transfer (Grey, p. 289). If an individual capitalizes on their right of first refusal, clearly the transfer is still productive and the water rights are being transferred to a higher-­‐
valuing owner. This individual must both agree to the same transfer stipulations as well as compensate the original parties for the costs associated with the development and negotiation of the transfer. Indeed, this compulsory compensation guarantees that the individual invoking the right of first refusal is the true HVO of the water rights. What this rule represents is a priority placed on those appropriating from the same water agency in the same local vicinity. This rule gives value to the belief that “all contractors have correlative rights to any surplus water that exists” within the jurisdiction of their agency (Grey, p. 289). It -­‐207-­‐ also removes the obligation of the DWR to review an out-­‐of-­‐basin transfer, which involves greater review costs than in-­‐basin transfers, which saves time and money on their end. The result is an efficient transfer that requires fewer costs. CONCLUSION Through the application of these four paramount characteristics of modern California water law, the State of California has been able to, to the best of its ability, allocate water efficiently. It has been essential, throughout California’s history, to allocate water as efficiently as possible due to water’s severe scarcity throughout much of the state. As the population and economy have grown, these pressures have only intensified. From the conception of the appropriative rights era, to the application of Article X and the public trust doctrine, to the facilitation of efficient transfers of water rights, the SWRCB has been able accomplish much in terms of efficiency in the face of complex water allocation issues. I had one major issue with the application of Article X when it stripped from private rights holders their due compensation after a taking. However, this would only have distributional consequences, and ultimately had no effect on efficiency. Moreover, the government clearly recognized this injustice by requiring compensation in multiple cases in the 2000s where Article X was utilized. While the administrative machine is not perfect, it is often much better than the strictly market alternatives. California has constructed an effective administrative body and set of water laws that overcome market failures when they arise, while simultaneously designing into the fabric of this administration and set of laws the utilization of the power of the market to assist in revealing -­‐208-­‐ the HVOs of water rights. I believe that, just as water law has evolved thus far in order to facilitate efficient allocations of water rights, California water law will continue to evolve into the future as new conditions arise. -­‐209-­‐ Conclusion Ronald Coase authored “The Problem of Social Cost” in 1960, but his fundamental insights are just as relevant today as they ever were. In a world completely devoid of transaction costs, all property rights would naturally flow to their highest-­‐valuing owners (HVOs) with no difficulty. Once all property rights were initially endowed, there would be nothing stopping individuals from bargaining as many times as necessary with as many people as necessary to ensure that all property rights migrated to their respective HVOs. A world without transaction costs would guarantee perfect efficiency. But, as I hope has become abundantly clear throughout this paper, transaction costs are rampant in the real world, having a profound effect on the ability of individuals to allocate property rights to their HVOs. The prevailing transaction costs of any region, locale, economy, or time period are integral to the formulation of governance structures for water as a resource. Transaction costs play a pivotal role in determining which governance structures will be most appropriate in facilitating efficient allocations of water rights. There are also distributional consequences associated with various governance structures, influenced by the existing transaction costs, of which lawmakers must be mindful. There are opportunities to achieve both efficiency and distributional goals when constructing -­‐210-­‐ governance structures for water so long as transaction costs are taken into account. Calabresi and Melamed (1972) offered two alternative property right structures that are differentially appropriate depending on the relevant transaction costs to bargaining for those property rights. The first structure is a strict property rights structure in which the only way to alienate an individual from their property right is to buy it from them in a voluntary bargain. Calabresi and Melamed showed how this structure is appropriate when all property rights are initially endowed and transaction costs to bargaining are low. If transaction costs are low enough, then individuals may bargain easily to achieve the efficient allocation of the property rights. Say I value your watch at a maximum of $7, you value your watch at a minimum of $5, and you start with the property right to the watch. In a situation of low or zero transaction costs, I can buy your watch from you for somewhere between $5 and $7 as the HVO of the property right to the watch, and we will both be better off as a result. Say I buy it from you for $6 – you make $1 in profit and I make $1 in profit, because I actually valued it at $7. We have produced $2 in surplus benefits where prior there were no surplus benefits. However, if transaction costs to bargaining with you were high, say $3, they would deter an efficient bargain for your watch. I would now have to pay you at least $5 plus the $3 in transaction costs for a total of at least $8, which is greater than the seven dollar maximum at which I value the watch. I am the HVO of your watch, but you keep the watch because we are unable to bargain due to transaction costs, and we have reached an inefficient outcome. -­‐211-­‐ Under such circumstances, Calabresi and Melamed proposed what is known as a liability rule to remedy the situation. If you and I exist in a high transaction cost world under a strict property rights regime, it might not be productive for me to buy your watch from you even if I am the HVO of the watch, as shown in the example above. The $3 in transaction costs would be enough to deter an efficient bargain. However, the government could impose a liability rule. In essence, you would still own the watch, but I could take it from you at any time so long as I compensated you at a fair price. In the example used above, I could walk up to you, take your watch, pay you $5 for it, and you would have no remedy for resistance. Paying you $5 for the watch would typically be the “fair market value” at which I would be obligated to compensate you. This way, it is guaranteed that you are not made worse off. You valued the watch at a minimum of $5, so I compensate you with $5 in exchange for taking your watch. You likely would have bargained for more than $5 for the watch in a voluntary negotiation, but with $3 in transaction costs, a voluntary negotiation is out of the question. Without a liability rule, you would keep the watch, and there would be no surplus benefits produced. However, with the imposition of the liability rule, you are made no worse off, having been compensated with $5, while I am made $2 better off, paying you $5 when I value the watch at $7. A liability rule, in this way, can produce benefits, achieving an efficient allocation of property rights, even in the face of transaction costs to bargaining because it eliminates the bargain. It is important to note that, when we voluntarily bargained under a strict property rights regime, we were both made $1 better off for a total surplus of $2. -­‐212-­‐ When the liability rule was imposed, you were made no better off and no worse off, while I was made $2 better off for a total surplus of $2. Imposing a liability rule has important distributional consequences when compared to a strict property rights rule. However, in this example, when there are transaction costs, no benefits would have accrued without the liability rule. Therefore, while a liability rule produces a less equal distribution of wealth than voluntary bargains, it is better than no voluntary bargain in the face of transaction costs because it at least produces benefits and achieves the efficient allocation of the rights. With or without a liability rule in the face of high transaction costs, you, the initial owner of the watch, are no better or worse off. Therefore, the liability rule has no affect on your condition but it makes me better off, making it a very useful tool. Looking at the experience of England and California with respect to water rights allocation has provided ample examples of how these principles apply in the real world. Before industrialization, English water rights holders faced a low transaction costs scenario, and thus a strict property rights regime was sufficient to encourage the efficient allocation of water rights. It was merely necessary for the common law courts to place an initial endowment of strict property rights and let voluntary bargaining facilitate the emergence of the HVOs of water rights. England accomplished this, first, with the ancient use doctrine, endowing all ancient users along England’s waterways with riparian water rights, forcing newcomers to engage in a voluntary bargain for the water rights or settle elsewhere along the sparsely populated waterways. Then, the courts upheld the -­‐213-­‐ first occupancy doctrine, endowing those who first invested in capital in the productive use of the river with strict property rights to the water. This had a distributional effect, because it stripped from some ancient users their ancient rights to the water, forcing them to prove themselves to be the HVOs by now bargaining in the opposite direction with the first occupants. However, an ancient user could also be the first occupant if he was the first to invest capital, which was certainly the case for many ancient users. The first occupancy doctrine only distributionally affected those ancient users who utilized their ancient rights through recreation and aesthetic appreciation rather than capital investments. While these values are still important, they were granted relatively less weight by the English courts in the face of economic growth and development. Moreover, many of these ancient users were quite well off, and if they were truly the HVOs of the water rights, they could still bargain easily enough with a first occupant to regain the water right under a low transaction cost scenario. Transaction costs would begin to increase rapidly during the pre-­‐
industrial and industrial periods, as water became highly valued for purposes of power production. Utilization of large water wheels for power production would be one of the early drivers of economic growth during the industrialization of England. With far more users along England’s waterways, bargaining with other users for water rights was no longer an easy task. In the face of growing transaction costs, the common law courts began to adopt a rule of reasonable use, which essentially nullified bargains by granting all users equal rights to the -­‐214-­‐ river flows. Granting equal rights to all riparians helped to maximize the number of water uses England could pack onto its waterways. It is also important to remember how the use to which the water was put played a fundamental role in determining which water rights would be the most effective in achieving the maximum productive value of England’s waters (i.e. the efficient allocation of water rights). The majority of riparians were using England’s waterways to produce power for emerging forms of industrial production. Very little water was actually consumed by watermills, so the natural flow of England’s waterways was hardly diminished for downstream uses by upstream uses. Therefore, the activities of upstream users generally had minimal effect on downstream users, and bargains over water rights were often unnecessary. England is also fortunate in that the entire country receives relatively large volumes of water through rainfall. Agricultural production, therefore, which is the largest consumer of freshwater worldwide, did not need to consume much water from waterways for irrigation because many crops could be nourished by England’s plentiful rainfall. As a result, the riparian right of reasonable use was able to maximize the number of users along England’s waterways, thus maximizing the productive value of the water in use, achieving an efficient allocation of water rights. The story of California water rights is perhaps much different in its outcome, but the same in the general conclusion that it supports. Different laws will be more or less appropriate in different regions given different natural and economic conditions and different transaction costs scenarios to achieve an -­‐215-­‐ efficient allocation of rights. Furthermore, the state, in recognition of the unique conditions under which it is operating, will actively pursue the governance structures that most effectively facilitate the efficient allocation of property rights. This was seen in England, and it also the case in California. The English common law was the reigning set of laws in many US states in the middle of the nineteenth century. This meant that the English common law of water rights, that of riparian rights of reasonable use, also reigned over water issues. However, the right of reasonable use was not appropriate for the early gold miners of the Gold Rush who needed to utilize California’s streams to mine gold. Once all the placer deposits of gold found in streambeds were exhausted, gold was found in larger quantities far removed from streams in mines on nonriparian lands. A new right was necessary to allow gold miners to access these new mines and to continue fueling economic growth. This reality fostered the birth of the right of prior appropriation, which allowed individuals to divert water away from riparian lands for use on nonriparian lands. Appropriators were the HVOs of the water, and were thus allocated the water rights. The supremacy of prior appropriation was confined primarily to federal lands, however, because it was on federal lands that gold mining originally took place. Once the US government began to release much of its federal land to private landowners in California, the riparian right of reasonable use returned. California courts recognized the English common law of riparian rights as the law that reigned, and so applied it on private lands. Early in California’s history, the population was still relatively low, and the primary use of water was -­‐216-­‐ agricultural production. Unlike England, California has relatively low rainfall, and much of the state is extremely arid. Therefore, early agricultural producers were most productive cultivating riparian lands because these lands were generally the most fertile. It is possible that these early riparians were indeed the HVOs of the water rights. Additionally, the reasonable use doctrine would have been appropriate because transaction costs were relatively low. Each riparian shared equal correlative rights to the water and, under a low transaction costs scenario of few water users, efficient voluntary bargains for greater or less volumes of water could occur. When conflict did arise, it would not have been difficult for riparians to achieve an efficient bargain rather than to access the courts. Indeed, I showed how this type of bargain was seen subsequent to the court decision in Lux v. Haggin. Once the property rights were confirmed, the parties to the suit were able to voluntarily bargain to achieve the efficient allocation of the water rights, transferring the rights to the HVO. Thus, for the most part, California courts upheld the riparian right of reasonable use. Later into the nineteenth century, however, more and more people were settling in California and there was growing demand for uses on nonriparian land unrelated to the cultivation of crops. While the riparian right of reasonable use was still the primary right applied on private lands, the right of prior appropriation began to compete with reasonable use for dominance. It was not that courts began to uphold prior appropriation as supreme to the riparian right of reasonable use; rather, appropriators that could put water to beneficial uses without harming riparians were allowed to do so. Many riparian-­‐appropriator -­‐217-­‐ conflicts were solved this way, as I showed in Chapter 3. When appropriators were causing no harm to riparian interests and were, in fact, increasing the productive value in use of the water, their uses were legally protected. This was an efficient allocation of water rights, allocating surplus water to additional users that could produce additional value. Thus, it is evident that the California courts were conscious of the efficiency consequences of their rulings on water rights, actively applying the appropriative and reasonable use rules differentially under different circumstances in order to allocate rights efficiently. Still, a growing recognition of appropriative rights represented more than just a periodic concession to appropriators when efficiency was obviously served under a “no harm, no foul” scenario. On the contrary, as the population of California began to grow exponentially and demands for water grew on nonriparian lands, of which there were many due to a paucity of streams in California, the right of prior appropriation became more and more important. Eventually, prior appropriation took over in 1913 when California transitioned into the modern era of administrative oversight of appropriative rights. The modern era is defined by the four major characteristics I discussed in Chapter 4: administrative permitting of appropriative rights, Article X, the public trust doctrine and associated environmental regulation, and the facilitation of water rights transfers. Because the issue of allocating water rights efficiently has grown in complexity and difficulty due to a very large population, thousands of competing uses, and the interconnectedness of all water uses, no one governance structure is going to work smoothly. Simply allocating strict -­‐218-­‐ appropriative property rights and then leaving efficiency to be determined by voluntary bargains would not always be enough. The transaction costs I discussed in Chapter 4 come into play, and would deter many efficient bargains. Article X and the public trust doctrine are both examples of how the government can apply a quasi-­‐liability rule in the name of the public interest. Article X is useful as a quasi-­‐liability rule because it encourages conservation and transfer of water to higher-­‐valued uses, achieving efficient transfers of water rights where the market is failing. The public trust doctrine is useful because it allocates or reallocates water rights to the public at large when the public on aggregate assumedly values the rights more than the private interests at stake. While the application of these tools have their own shortcomings, I believe they are better than the alternative, which is that wasteful users of water would often go unrecognized and the large public values in recreation, fishing, wildlife preservation, ecosystem services, and navigation would often go unprotected. Lastly, the California water law of transfers effectively performs the task of facilitating efficient short-­‐ and long-­‐term transfers of water rights. With the State Water Resources Control Board as a third-­‐party arbitrator and record-­‐keeper, the law capitalizes on the voluntary nature of all relevant bargains, minimizing inefficient administrative interventions and maximizing the chance that water rights are allocated to their HVOs, achieving the efficient allocation of water rights. The evolution of water law in England and California support both the proposition that different governance structures are appropriate under different -­‐219-­‐ conditions to achieve the efficient allocation of water rights as well as the proposition that lawmakers, courts, and administrations will actively pursue whatever governances structures are believed to best achieve the efficient allocation of water rights. However, my thesis focused on two western civilizations, both of which were heavily influenced by one another. Both England and the United States share in common many goals, cultural norms, and economic and social structures. It comes as no surprise to me that lawmakers in these nations would pursue legal structures that encourage the efficient allocation of water rights. Both nations have been, throughout their histories, among the most powerful democratic and capitalist nations in the world. Efficiency, growth, and progress are integral aspects of our societies, our intellectual pursuits, our cultural spirit, and our productive activities. Indeed, there is evidence that distributional consequences were considered and given weight in both nations, but efficiency seemed to be, ultimately, the supreme purpose of water law. I would be interested to know more about the evolution of water rights in other nations with different historical and cultural backgrounds. Has efficiency in the use of resources always been just as important? How do distributional concerns compare? Have values changed over time? Whereas efficiency seems to be the driving force behind the evolution of the western law of water rights, is there a different driving force behind the evolution of water law found in other nations of similar cultural backgrounds? I would be interested to see a cross-­‐
cultural comparison of this evolution of water rights. Moreover, I wonder how -­‐220-­‐ these evolutionary trends apply when other forms of property rights are analyzed. Or, how does the evolution of rights to other sources of water, like groundwater, aquifers, or oceans, compare to the evolution of surface water rights? Could all property rights in the United States in England be traced as an evolution of law chasing the goal of efficiency? How does the evolution of property rights on the whole compare across nations? Across cultures? Could the United States take any lessons from other cultures about how to structure our legal system to achieve our pre-­‐defined goals as well as how to, perhaps, redefine our goals in a way that might affect our society in a positive way? Indeed, the idea of a common-­‐pool resource (CPR) regime to govern the use of water has, in the past, been neglected or not even considered in the first place. Traditional economists historically rejected the project of governing resources under a CPR regime as implausible. Yet, Elinor Ostrom, a Nobel Prize winning economist, devoted much of her academic life to the study of CPR institutions, thoroughly documenting in her 1990 book “Governing the Commons” (Ostrom, 1990) how CPR institutions can often more effectively, and more efficiently, govern water resources. She used examples from many different cultures and nations, including the CPR governance of aquifers in twentieth century California. In the same way that the success of CPR institutions has called into question the traditional game theory assumptions of many economists, I wonder what other institutions might be plausible as alternatives to the types of rights regimes western legal systems typically employ. -­‐221-­‐ Behavioral economics is also a fast-­‐growing field that, too, calls into question many traditional notions taken for granted in economic literature. This field is founded on the principle of empirical investigation into the actual behavior of humans in all the complex situations in which we find ourselves in order to determine how, in reality, we behave, interact, and consume. It is essentially psychology as applied to economics. Rather than theorize from an abstract perspective, behavioral economics starts with no presumptions about human behavior in an economic setting and, instead, conducts experiments in order to come to empirical conclusions about human rationality, choice, decision-­‐making, interaction, and behavior in a multitude of contexts. Further, behavioral economics seeks to illuminate how certain situations can be purposefully constructed so as to nudge individuals toward a desired outcome given principles of behavior shown through behavioral experiments. My next project would be to apply lessons from behavioral economics to water law. I believe that basic economic incentives and legal structures can go a long way in facilitating the efficient allocation of property rights. However, I wholeheartedly believe in “behavioral failures,” our basic human imperfections that cause us to act in ways unpredicted by traditional economic theory. There is a large behavioral economics and behavioral law and economics literature that seeks to address how humans truly behave in economic contexts and how they can be nudged in certain directions. I would love to see more literature applying lessons from psychology and behavioral economics to the general field of economics, and specifically law and economics, in order to determine how legal -­‐222-­‐ structures can be subtly or majorly altered in ways unthinkable to the traditional economist in order to achieve the efficient allocation of property rights. Finally, I believe that future literature could focus more heavily on the institutions that allocate water to domestic users and industrial users. Domestic uses are still relatively small compared to agricultural uses, but they are growing. Policymakers tend to have an aversion to increasing the price of domestic water because administrations that do this generally receive intense public backlash. What better way to induce conservation in water use than to raise prices? What other options do policymakers have to induce conservation in domestic water use? How can lessons from behavioral economics be applied? Industrial water users are also taking note of the importance of water conservation. While they are not generally doing so out of the kindness of their hearts, industrial users respond to price incentives. Big businesses that use significant volumes of water as an input to production can be influential drivers of water conservation initiatives. 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bles Williamson, Oliver E. “The Economic Institutions of Capitalism.” New York: Free Press, 1985. CASES: English common law cases: Bealey v. Shaw, 102 ER 1266 (1805). Commonwealth Legal Information Institute. Web. Winter 2013. <http://www.commonlii.org/uk/cases/EngR/> -­‐227-­‐ Conger v. Weaver, 6 Cal 548 (1856). Commonwealth Legal Information Institute. Web. Winter 2013. <http://www.commonlii.org/uk/cases/EngR/> Countess of Rutland v. Bowler, 81 ER 1087 (1622). Commonwealth Legal Information Institute. Web. Winter 2013. <http://www.commonlii.org/uk/cases/EngR/> Eddy v. Simpson, 3 Cal 249 (1853). Commonwealth Legal Information Institute. Web. Winter 2013. <http://www.commonlii.org/uk/cases/EngR/> Embrey v. Owen, 155 ER 579 (1851). Commonwealth Legal Information Institute. Web. Winter 2013. <http://www.commonlii.org/uk/cases/EngR/> Hicks v. Bell, 3 Cal 219 (1853). Commonwealth Legal Information Institute. Web. Winter 2013. <http://www.commonlii.org/uk/cases/EngR/> Irwin v. Phillips, 5 Cal 140 (1855). Commonwealth Legal Information Institute. Web. Winter 2013. <http://www.commonlii.org/uk/cases/EngR/> Luttrel’s Case, 76 ER 1065 (1601). Commonwealth Legal Information Institute. Web. Winter 2013. <http://www.commonlii.org/uk/cases/EngR/> Moore v. Brown, 73 ER 723 (1572). Commonwealth Legal Information Institute. Web. Winter 2013. <http://www.commonlii.org/uk/cases/EngR/> Russell v. Handford, 74 ER 248 (1583). Commonwealth Legal Information Institute. Web. Winter 2013. <http://www.commonlii.org/uk/cases/EngR/> Sands v. Trefuses, 79 ER 1094 (1639). Commonwealth Legal Information Institute. Web. Winter 2013. <http://www.commonlii.org/uk/cases/EngR/> Smith v. Babb, 74 ER 815 (1588). Commonwealth Legal Information Institute. Web. Winter 2013. <http://www.commonlii.org/uk/cases/EngR/> Sury v. Pigot, 79 ER 1263 (1625). Commonwealth Legal Information Institute. Web. Winter 2013. <http://www.commonlii.org/uk/cases/EngR/> William Aldred’s Case, 77 ER 816 (1610). 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Web. Winter 2013. <http://www.lexisnexis.com/hottopics/lnacademic/?> Edgar v. Stevenson, 70 Cal 286, (1886). LexisNexis Academic. Web. Winter 2013. <http://www.lexisnexis.com/hottopics/lnacademic/?> Fifield v. Spring Valley, 130 Cal 552 (1900). LexisNexis Academic. Web. Winter 2013. <http://www.lexisnexis.com/hottopics/lnacademic/?> Gould v. Eaton, 117 Cal 539 (1897). LexisNexis Academic. Web. Winter 2013. <http://www.lexisnexis.com/hottopics/lnacademic/?> Hargrave v. Cook, 108 Cal 72 (1895). LexisNexis Academic. Web. Winter 2013. <http://www.lexisnexis.com/hottopics/lnacademic/?> Heilbron v. Fowler Switch, 75 Cal 426 (1888). LexisNexis Academic. Web. Winter 2013. <http://www.lexisnexis.com/hottopics/lnacademic/?> Heilbron v. Last Chance, 75 Cal 117 (1888). LexisNexis Academic. Web. Winter 2013. <http://www.lexisnexis.com/hottopics/lnacademic/?> Heilbron v. 76 Land and Water, 80 Cal 189 (1899). LexisNexis Academic. Web. Winter 2013. <http://www.lexisnexis.com/hottopics/lnacademic/?> Huffner v. Sawday, 153 Cal 86 (1908). LexisNexis Academic. Web. Winter 2013. <http://www.lexisnexis.com/hottopics/lnacademic/?> -­‐229-­‐ Last Chance v. Heilbron, 86 Cal 1 (1890). LexisNexis Academic. Web. Winter 2013. <http://www.lexisnexis.com/hottopics/lnacademic/?> Lux v. Haggin, 69 Cal 255 (1886). LexisNexis Academic. Web. Winter 2013. <http://www.lexisnexis.com/hottopics/lnacademic/?> Miller v. Bay Cities, 157 Cal 256 (1910). LexisNexis Academic. Web. Winter 2013. <http://www.lexisnexis.com/hottopics/lnacademic/?> Miller v. Madera, 155 Cal 59 (1909). LexisNexis Academic. Web. Winter 2013. <http://www.lexisnexis.com/hottopics/lnacademic/?> Modoc v. Booth, 102 Cal 151 (1894). LexisNexis Academic. Web. Winter 2013. <http://www.lexisnexis.com/hottopics/lnacademic/?> Montecito v. Santa Barbara, 151 Cal 377 (1907). LexisNexis Academic. Web. Winter 2013. <http://www.lexisnexis.com/hottopics/lnacademic/?> Moore v. Clear Lake, 68 Cal 146 (1885). LexisNexis Academic. Web. Winter 2013. <http://www.lexisnexis.com/hottopics/lnacademic/?> Mott v. Ewing, 90 Cal 231 (1891). LexisNexis Academic. Web. Winter 2013. <http://www.lexisnexis.com/hottopics/lnacademic/?> Newport v. Temescal, 149 Cal 531, (1906). LexisNexis Academic. Web. Winter 2013. <http://www.lexisnexis.com/hottopics/lnacademic/?> Pope v. Kinman, 54 Cal 3 (1879). LexisNexis Academic. Web. Winter 2013. <http://www.lexisnexis.com/hottopics/lnacademic/?> Riverside v. Gage, 89 Cal 410, (1891). LexisNexis Academic. Web. Winter 2013. <http://www.lexisnexis.com/hottopics/lnacademic/?> San Joaquin V. Fresno Flume, 158 Cal 626, (1910). LexisNexis Academic. Web. Winter 2013. <http://www.lexisnexis.com/hottopics/lnacademic/?> San Luis v. Estrada, 117 Cal 168, (1897). LexisNexis Academic. Web. Winter 2013. <http://www.lexisnexis.com/hottopics/lnacademic/?> Senior v. Anderson, 130 Cal 290, (1900). LexisNexis Academic. Web. Winter 2013. <http://www.lexisnexis.com/hottopics/lnacademic/?> Spargur v. Heard, 90 Cal 221 (1891). LexisNexis Academic. Web. Winter 2013. <http://www.lexisnexis.com/hottopics/lnacademic/?> -­‐230-­‐ Vernon v. Los Angeles, 106 Cal 237, (1895). LexisNexis Academic. Web. Winter 2013. <http://www.lexisnexis.com/hottopics/lnacademic/?> Wutchumna v. Pogue, 151 Cal 105, (1907). LexisNexis Academic. Web. Winter 2013. <http://www.lexisnexis.com/hottopics/lnacademic/?> Modern Era California Court Cases: Imperial Irrigation District v. State Water Resources Control Board, 186 Cal App 3d 1160 (1986). LexisNexis Academic. Web. Winter 2013. <http://www.lexisnexis.com/hottopics/lnacademic/?> Joslin v. Marin Municipal Water District, 67 Cal 2d 132 (1962). LexisNexis Academic. Web. Winter 2013. <http://www.lexisnexis.com/hottopics/lnacademic/?> National Audubon Society v. Superior Court, 33 Cal 3d 419 (1983). LexisNexis Academic. Web. 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