Drought and Optimal Groundwater Managment

This paper considers the problem of a water management authority that is faced with the threat of a drought that will take place at an uncertain date. Three management policies are investigated: i) the laissez-faire policy of automatic regulation through Open Access mechanisms, ii) the policy of keeping a rationed level of water usage until the water table is restored, and iii) an economically optimal policy taking account of the probability of a drought and the fact that water is an asset (a stock of natural capital). In particular, it is shown that the optimal pre-drought steady-state stock of water is smaller than the stock that would be optimal in the no-drought case. Hence, no precautionary stock is built up. However, a more extensive drought period will lead to a larger pre-drought steady-state stock.