This morning, Marketplace aired a feature that discussed water shortages on Washington farms. Under riparian law in the state, farmers with “junior water rights” can purchase rights from “senior” holders. For some farmers who have “senior” rights, and low-yield crops (such as hay) it may be more profitable to sell their water than to farm their land.

Joe Cook, an environmental economist at the University of Washington, explained how a water market works:

“Some farmers would go to other farmers and say, ‘Hey, are you willing to let me use your water so I can water my vineyard, or my orchard, or a crop that I really can’t let go dry?’”

In other words, the water’s so valuable that farmers with low-value crops could choose to make money by selling their water instead of planting for a season. Right now, those farmers have little incentive to sell their water to other farmers, in part because there’s a complex legal process involved.

This dynamic is a perfect illustration of how the Coase Theorem is supposed to work. In the absence of transaction costs, parties will negotiate in such a way to yield the greatest aggregate benefit. In Washington a vineyard owner with junior rights, who creates profitable wines, can pay a hay farmer with senior rights (and low profits) to not farm, and instead relinquish his water supplies.

Why isn’t this being done now? As Coase would predict, the transaction costs imposed by regulations are too high. As a result, the government is looking to make it easier to exchange water rights:

That’s what Washington officials are trying to fix. Legislators are still working to secure final funding for the plan, but once it’s in place, it could serve as a model for how to make sure water flows toward the highest-value agriculture.

What a perfect articulation of the Coase Theorem. Markets!