HBS Cases: Who Controls Water?
In a recent field study seminar, Professor Forest L. Reinhardt discussed the case "Woolf Farming & Processing," which illustrates how access to water—a basic building block of agriculture—is affected by everything from complex government-mandated requirements to a 3-inch endangered bait fish.
Although much of the globe is awash in it, the allocation of water for human consumption is anything but easy. As the planet's population grows, urbanizes, and is subjected to climate change, many experts foresee a global water crisis (and resulting food shortages and increasing prices) looming over the next 40 years.
"The basic problem from the farmers' point of view is that the water is in the wrong place at the wrong time."
The 2009 case "Woolf Farming & Processing" illustrates many of these challenges through the eyes of Stuart Wolf, a central California family farmer who must grow crops even as the available water supply to his operation is curtailed by drought conditions, court decisions, and quotas imposed by government agencies.
The case examines how water, a basic building block of agriculture, is affected by a complex web of political, environmental, and agricultural pressures, and the effects those impacts have on business, society, and global food production.
"Like all good cases it's a good story, and like all good cases it also tells you something more general about important problems," said Forest L. Reinhardt, the John D. Black Professor of Business Administration at Harvard Business School.
Reinhardt led a discussion of the case recently in the MBA field study seminar Innovation in Business, Energy, and Environment, held in Harvard's Innovation Lab. The case was prepared by HBS Professor David E. Bell, Laura Winig, and Mary Shelman (HBS MBA'87), director of the Agribusiness Program at HBS.
A family farm
Woolf Farming & Processing, established in 1974, is located in the southern part of California's Central Valley, one of the most fertile areas in the country. The valley has been heavily farmed since the the 1850s, and through the years sharp rises in agricultural production and population quickly depleted the local water supplies.
In response, the state and federal governments stepped in and created a water infrastructure of dams and aqueducts that Reinhardt said was "overcommitted the day it was built." The last project was completed in the 1960s, when California had a much smaller population, with much smaller bank accounts. Woolf Farming & Processing—along with thousands of other farmers—relies on this aging infrastructure. Stuart Woolf and his father, Jack, before him had invested heavily in water management technologies because they were aware of its weaknesses.
"The basic problem from the farmers' point of view is that the water is in the wrong place at the wrong time," said Reinhardt.
It's also one of the reasons why a sustained drought in the late 2000s laid 450,000 acres of Central Valley farmland fallow, which pushed local unemployment rates as high as 40 percent, drove protesters into the streets, and led Woolf to cut his crop back dramatically, at one point grinding up 90,000 water-hungry almond trees.
Throughout the discussion, Reinhardt worked with students to sort out a complex tangle of interdependent contributing factors.
Environmental and legal issues muddy the water, for example. In the mid-2000s efforts to save a 3-inch fish called the delta smelt from extinction led to a ruling by a US district court judge that significantly limited the amount of water that could be pumped to farms out of the Sacramento-San Joaquin River delta. The theory behind the ruling was that the smelt were sensitive to salinity levels, which rose as water levels lowered.
The Endangered Species Act is another factor working against the farmers.
"The Endangered Species Act is an interesting piece of legislation," said Reinhardt. "The federal government has to do everything it can to reduce the probability of extinction. It's explicitly prohibited in the statute from balancing costs and benefits…It doesn't even matter if you have little prospect of saving the fish. You still have to spend any amount of money you can to protect it."
It's easy to count the damages to the farmer, he added, but very difficult to value the damage caused by the extinction of the smelt.
"The environmentalists argue that if you let the bureaucrats do cost-benefit analysis, the fish will lose every single time," he said. "And you'll have extinction after extinction after extinction."
But the farmers benefit from other political decisions. Because of government subsidies, the price some pay for whatever water they do get is a fraction of its actual cost.
Reinhardt shifted the conversation to discussing solutions, such as assigning property rights to water.
"In a way the history of Europeans and Asians on this continent has been the story of environmental abundance converted to scarcity through systems of open property access, which then lead to the creation of private property rights because that's the only way of solving the problem," he said.
Solving the problem by treating water like any other commodity sparked lively discussion.
"If the world trade system founders it's going to founder in food."
"Farmers would probably have a price of water that would be significantly higher than it is right now so they probably would not plant thirsty crops," remarked one student. "The market would sort out the farmers and the environmentalists somewhere in the middle…the environmentalists would save the species they really wanted to save."
"With a completely free market with no restrictions, I can at least imagine an outcome where there is a winner," said another student. However, the losers in such a free market would not survive.
Yet a market that guarantees people will get the water they need to support basic human survival is not the perfect solution either. "You still have the problem of the huge year-to-year volatility of water available," said one student.
"You absolutely have a massive hydrological risk," replied Reinhardt, a risk currently borne by the farmers, since the environmental flow of water is inelastic because of the Endangered Species Act.
"The farmers would still have risk," he continued. "But it would be price risk instead of quantity risk…If there's a market, clearly the price is going to be higher than the price that some farmers are going to be able to afford."
This could be a good thing for Woolf Farming & Processing because it could purchase, on the cheap, neighboring farms that didn't invest in water conservation technologies. Stuart Woolf might then be better positioned to meet his own objective, as stated in the case: "to be a part of a food system that would feed a growing world population with fewer resources."
World food prices are a definite concern. "The inflation-adjusted price of food has been falling over time," said Reinhardt. "People used to spend 50 percent of their income on food." For residents of wealthy nations, that number has dropped to 2 percent. "Most people don't think about whether that decline will continue or not," he added. If it does not, "the world is going to be a very, very different place…If the world trade system founders it's going to founder in food."
Other options were also discussed: moving out of California and buying land in more politically, geographically, and economically friendly countries; planting less thirsty crops; and giving up farming altogether and switching to the solar energy business, for instance.
In the end, the class did not come up with a clear solution—because there isn't one.
Societies persuade institutions to solve one set of problems. If the institutions are successful, more prosperity is created, which leads to the obsolescence of the very institutions that created the prosperity. Eventually there's the need to create institutions to manage the new disparity. "It's an old story, "Reinhardt said. "And that's the position in which we find ourselves in California."