Groundwater and Crop Choice in the Short and Long Run

Abstract

How do agents respond to policy when investments have high upfront costs and lasting payoffs? We estimate farmers’ short- and long-run responses to changes in groundwater pumping costs in California, one of the world’s most valuable agricultural regions, where perennial crops with these investment dynamics are prevalent. We leverage quasi-experimental variation in groundwater costs driven by regulated electricity tariffs to estimate a dynamic discrete choice model of land use with state dependence and forward-looking farmers. Farmers’ short-run elasticity of groundwater demand is −0.72, but temporary cost shocks do not induce crop switching. In contrast, their long-run elasticity is −0.48, driven by a shift away from unsustainable short-run coping strategies and towards meaningful reductions in water-intensive perennial cropping and increased fallowing. California’s flagship groundwater sustainability targets will require a 47% tax in regulated areas on average, which would lower perennial acreage by 10% and increase fallowing by 18%.