Groundwater and Economic Dynamics, Shadow Rents and Shadow Prices: The Punjab

Abstract

This study investigates the effect of electricity subsidies on economic and groundwater dynamics. The analysis follows from a dynamic, multisector and general equilibrium model in which both aquifer hydrology dynamics in the Punjab region of India and capital accumulation across India are endogenous. The model predicts Punjabi aquifer depletion which has distinct regional impacts and slight spillovers on the rest of the Indian economy. From the Punjab perspective, electricity subsidies encourage higher levels of groundwater extraction than one would observe in the absence of the subsidy. In turn, the higher levels of groundwater extraction increase agriculture's ability to compete for labor and other farm inputs. Even with the subsidy, however, as the economy transitions to the long run equilibrium, groundwater tables fall and more electricity is needed to supply the same amount of water used in the previous period. These forces slowly diminish agriculture's ability to compete for resources and the sector eventually loses resources to the rest of the economy and in turn, agricultural income falls over time. These dynamics are accentuated when the subsidy is removed, leading to a more rapid decline in Punjabi agricultural income. Our empirical findings suggest eliminating the 'electricity for irrigation' subsidy leads to double gains: An environmental gain and an economic gain. The environmental gain is a slower rate of aquifer depletion over time relative to a subsidy world. Removing the subsidy discourages production of high water-intensive crops, thus slowing the rate of groundwater extraction. Although removing the subsidy increases agricultural production costs, it makes electricity less expensive for competing sectors, namely manufacturing, which in turn leads, over time, to increased electricity, capital and labor demand from manufacturing. This reallocation of resources to more productive sectors in the economy leads to an increase in Punjabi gross state domestic product, as compared to the case where electricity is subsidized. The empirical results suggest removing Punjabi electricity subsidies entails trade-offs between agricultural and manufacturing income and has implications for long term water use. Empirical results also suggest that correctly calculating the "stock" value of a natural resource requires macroeconomic data and hence, may be impossible to conduct in a partial equilibrium setting.