This is our 3rd blog post for our Job Market Paper Series blog for 2025-2026.
Maximiliano Garcia is a Postdoctoral Research Associate at Brown University. His research interests lie at the intersection between development economics, environmental economics, and political economy
Climate change is deeply intertwined with the Tragedy of the Commons: the overuse and collapse of shared resources. It emerges from a global commons problem—the unrestricted emission of greenhouse gases—and, in turn, exacerbates pressures on other common-pool resources, such as groundwater. The increasing frequency of droughts worldwide (IPCC, 2021) underscores the urgency of managing these resources more effectively.
In recent decades, environmental markets—covering resources like carbon emissions, fisheries, forestry, and water—have been introduced as a way to limit open access and compel users to internalize the externalities of their actions. Yet despite their growing popularity, our understanding of the institutions needed to sustain the operation of these markets remains limited, especially in developing countries. Managing common-pool resources poses intrinsic challenges: high exclusion and monitoring costs often persist even when legally clear property rights exist.
In my Job Market Paper, I use within-country variation in property-rights institutions to show empirically that water markets may fail to allocate water efficiently despite the presence of well-defined legal rights. I then examine how specialized enforcement institutions can dramatically improve their performance.
A Market Designed to Implement the Coase Theorem—And Why It Failed
I study a unique setting where policymakers explicitly tried to put the Coase Theorem into practice—the idea that if users have secure property rights, they can negotiate among themselves to solve externalities without government intervention. Chile’s 1981 Water Code created one of the world’s first markets in tradable water rights, granting users secure, transferable rights so that water would flow to those who valued it most through voluntary exchange rather than state allocation.
However, this experiment revealed an important paradox. The very restrictions on government intervention meant to protect users from expropriation undermined enforcement, making it difficult to ensure compliance. This problem is especially visible in long rivers: upstream users can divert water before it reaches downstream users, effectively gaining priority by mere geographic proximity—particularly during droughts.
Chile thus provides an exceptional natural experiment. While the national legal framework is uniform and the rule of law ranks comparably to that of the United Kingdom, local implementation varies widely. Across the country, the presence and effectiveness of self-governed irrigators’ organizations—known as Juntas de Vigilancia or Water Boards—create sharp contrasts in governance quality. This variation allows a clean empirical test: does stronger local governance actually improve water market outcomes?
Institutions in Action: How Water Boards Enforce Rights
Figure 1 illustrates the core problem. During a drought, when infrastructure does not physically constrain withdrawals (top left panel), upstream farmers can take more than their entitled share, leaving little or nothing for those downstream. Water Boards, by contrast, implement rotational irrigation schedules that match each user’s legal entitlement. As shown in Figure 1 (right panel), they can literally lock the gates of upstream canals when it is not those users’ turn, allowing water to flow downstream to those legally entitled to receive it (Figure 1a, bottom right panel).
In essence, these local institutions translate paper rights into enforceable realities.
Measuring Efficiency: A New Misallocation Test
To evaluate the effects of these institutions, I develop a novel sufficient-statistic misallocation test that recovers the marginal product of water (MPW) from variation in rainfall timing. This approach exploits naturally occurring shocks in rainfall timing and intensity, interacted with predetermined farm choices and characteristics, to test whether the marginal value of water is equalized across users within a basin. The idea is straightforward: if giving an extra unit of water to one farmer increases output more than giving it to another, then the allocation is inefficient.
In practice, however, directly measuring water usage is notoriously difficult—especially in regions without active enforcement. Unlike most existing approaches (e.g., Rafey, 2023), this test does not require measurement of water consumption, and relies on relatively little data, making it implementable in other developing-country settings. Moreover, it detects misallocation even after accounting for farmers’ long-run and short-run adaptive responses.
The results are clear: water markets only work where local enforcement exists. Basins without Water Boards systematically fail the test: downstream farmers are water-constrained while upstream users enjoy excess access, indicating inefficient allocation. In contrast, basins with Water Boards pass the test, demonstrating near-equalization of expected marginal products across locations. Figure 2 (left panel) presents the estimated marginal product of water as a function of position within the river basin.
What Drives the Differences? Redistribution and Adaptation
The second part of the paper explores the mechanisms behind these differences. Are they simply redistributive, or do they reflect deeper adaptive responses?
To address this, I assembled an exceptionally rich dataset: more than 25 years of satellite data on water consumption and agricultural activity at the plot level for more than 90,000 agricultural land plots with access to canals, merged with national administrative records, agricultural censuses, and streamflow data. I exploit the independent, staggeredadoption of Water Boards to implement event-study and instrumental-variable designs, tracing both short- and long-run impacts.
Following the establishment of these institutions, enforcement generates large-scale redistribution of water. As shown in Figure 2b, downstream farmers increase water consumption by two standard deviations of their pre-adoption distribution within seven years, while upstream users reduce consumption by nearly one. The effect is substantial enough to alter river hydrology: summer streamflow rises by 25%, with no change in non-irrigation seasons.
Yet this redistribution does not reduce overall productivity. Downstream yields increase by about 0.6 standard deviations, while upstream yields remain statistically unchanged, suggesting that upstream users were not making efficient use of the extra water because they did not face scarcity. These findings indicate that enforcement corrects misallocation—allowing water to flow toward higher-value uses—without harming aggregate output.
Long-Run Impacts: Technology, Crop Choice, and Inequality
To understand longer-term adaptation, I use an instrument based on the costs of establishing Water Boards, which isolates plausibly exogenous variation in institutional formation. This allows me to study how improved governance affects technology adoption and crop choice—the two main channels of adaptation in agriculture.
Downstream farmers under active Water Boards lengthen their growing seasons and shift toward higher-value crops, indicating increased reliability of water supply. However, financial constraints shape who benefits most. Only larger farms are able to invest in efficient irrigation technologies such as drip systems. Consequently, the long-run increase in water consumption among large downstream farms is roughly three times greater than that of smaller ones.
These heterogeneous effects highlight that even successful governance reforms can widen inequalities in adaptive capacity.
Implications: Governing Environmental Markets
Taken together, these findings suggest that water markets—like all environmental markets—face distinctive challenges that make property rights alone insufficient. Protecting property over water is not as simple as fencing land. Effective governance requires ongoing monitoring, coordination, and dynamic enforcement.
In Chile, Water Boards have proven to be a powerful institutional response. By aligning enforcement power and accountability in a single, locally grounded entity, they convert a Tragedy of the Commons into a Principal–Agent problem, one that can be managed through shared rules and social oversight.
While the specific form of governance may differ across environmental goods, geographies, and contexts, the broader message is universal: legally well-defined property rights are not enough. Environmental markets require capable institutions to function effectively. Without them, efficiency losses proliferate; with them, markets can realize their potential to allocate scarce resources productively, although the question over how to address equity concerns remains open.
