A Theoretical Analysis of Bargaining and Interstate Water Compacts

Freshwater is becoming increasingly scarce across the globe, leading to conflict over property rights for existing freshwater resources. One realization of such conflict is found in the allocation among states of interstate rivers in the United States. While interstate water markets seem like the natural solution to such allocation problems, they are rare and, property rights needed to achieve efficient market outcomes must first be well-defined through negotiated agreements, Interstate River (or Water) Compacts. To date, the process through which these compact agreements are reached has not been studied from an economics perspective. Using a sequential-offer bargaining model based on the work of Krishna and Serrano (1996) with an uncertain outside option, this paper analyzes the negotiation of interstate compacts, and compares the equilibrium allocation of a compact to a set of conditions that characterize a proposed optimal allocation. The primary result of my theoretical model is that compact allocations will tend to favor equitable allocations over- efficient allocations, over-allocating water to relatively low-value and less risk averse states at the expense of higher-value states and more risk averse states. I assess two possible policy solutions to improve the efficiency of interstate compacts