Missing markets and redundant reservoirs - Dams as a consequence of inefficient groundwater management policies

This paper uses a two-sector, two-period, spatial model of groundwater usage with stochastic surface water supply to illustrate the potential for the suboptimal management of the timing of groundwater uses. A "time profile externality" is said to exist when the timing of groundwater extraction by one set of users impacts on the time profile of water availability to another set of users. The existence of the time of use externality depends on the presence of important differences in the preferences between the control and non-control sectors. It also depends on the absence of the markets that would internalise these differences. One important implication of the existence of such externalities is that they can induce sub-optimal insurance investments in the form of water storage capital, i.e., unnecessary surface water reservoirs.