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April 30, 2005

Chinatown Revisited

Los Angeles, it is widely believed, was able to become a major city only after stealing water from farmers elsewhere in California in the 1920s. The problem with this belief? It’s false. By Gary D. Libecap.


“Do you have any idea what this land would be worth with a steady water supply? About $30 million more than they paid for it.”

—J. J. Gittes (Jack Nicholson), referring to land in the
San Fernando Valley, in the movie Chinatown (1974)

The story of how Owens Valley lost its water to Los Angeles in the early twentieth century remains a vital part of both the West’s history of settlement and the contemporary struggle over water markets. It is cited by opponents of the sale of rural water as an example of all that can go wrong with such practices. Even proponents of contemporary water exchanges emphasize that their proposals will not be another Owens Valley.

Begun in 1905 and completed in 1935, Owens Valley was the first large-scale rural-to-urban water trade. Although the story resonates most forcefully in dry regions of western states, it has been invoked throughout the country as a warning to rural communities faced with burgeoning urban populations whose expanding demand for water exceeds available supplies.

All this makes it worthwhile to examine the Owens Valley story more completely and more objectively than has been done in the past. I hope to show that the common judgments about Owens Valley are at best incomplete and at worst inaccurate. Historical events are often misinterpreted—or misrepresented—with little consequence. Owens Valley, however, is different. The way in which its story is recounted undermines legitimate efforts to trade water voluntarily to meet growing urban and environmental demands in the semi-arid West. The true lessons of Owens Valley have been lost.

The need for water exchanges and markets is obvious. The most rapid population growth in the United States is in the urban areas of the semi-arid West. This growth is fueled by shifts from agriculture and extractive industries to service and technology industries. Most western cities, such as Los Angeles, Las Vegas, San Diego, Phoenix, Denver, and Tucson, do not have sufficient local water sources to accommodate the growing demand. At the same time environmental concerns create growing demands for water to maintain stream flows and protect riparian regions. Because few options exist for increasing supplies, those demands must be satisfied by re-allocating water from agriculture, which currently accounts for 70 to 80 percent of annual water use. Water markets to facilitate the voluntary transfer of water from lower- to higher-valued uses are a logical option.

Certainly, the price differences between water use in agricultural and urban contexts appear to be large enough to promote water trades. For instance, groundwater for farming near Marana, in Pima County, Arizona, costs approximately $25 per acre-foot (approximately 325,000 gallons); for urban use, the same water costs $200 and more. Agricultural water prices are kept artificially low by Bureau of Reclamation policies and other federal and state government programs to subsidize farming. In recent efforts to secure Imperial Irrigation District water, San Diego offered $225 per acre-foot for water that farmers were using for $15.50.

These extreme differences in price indicate that trades would benefit both buyers and sellers. If more trade took place, urban buyers could get water more cheaply and rural sellers could earn much more from their water than they do now in farming. There would be less waste of water. But the development of water markets has been limited and is controversial for a variety of reasons.

Hovering over any discussion of rural-urban water exchanges is the “ghost of Owens Valley,” whose general themes are theft of the valley’s water, destruction of the local agricultural economy, and colonization of the region by a remote, disinterested city. According to that popular view, powerful, unscrupulous promoters of Los Angeles grabbed the valley’s water from unwitting farmers and “flushed” it down the Los Angeles Aqueduct, turning previously verdant, irrigated farmland into desert, leaving the skeletons of abandoned homesteads, empty schoolhouses, and dry ditches. This compelling image looms as a cautionary parable against contemporary water transfers. Rural communities considering sales of water today shy away from so grim a potential outcome.

The story of Owens Valley is repeated in the academic and popular presses. The 1974 movie Chinatown, starring Jack Nicholson and Faye Dunaway, added to the story’s notoriety by dramatizing alleged conspiracies involving the valley’s water and land speculation in Los Angeles. Because the Owens Valley story is of more than historical interest, it is worth reexamining to better understand the relationships between farmers and the Los Angeles Department of Water and Power (LADWP, or the Water Board), the outcomes of the land and water-rights purchases, and the sources of the disputes that took place in the early twentieth century.
 

The Facts

Owens Valley is on the eastern side of California’s Sierra Nevada, near the Nevada border. It is home to most of the population and farming activities in Inyo County. The valley—approximately 120 miles long and up to 6 miles wide—is bisected by the Owens River, which historically dumped its water into the shallow, alkaline Owens Lake. The Sierra snowpacks feed a lot of water into the Owens River and the valley’s aquifers: some 37 million acre-feet, about the same as the volume of Lake Mead, the giant reservoir formed by the Hoover Dam.

In 1920, just before most of the major purchases of water by Los Angeles were made, slightly more than 7,000 people lived in the area, on farms and in five small towns. Los Angeles wanted to buy the area’s small farms in order to secure their water rights, and there were good reasons for the farmers to sell. Less than half the region’s 140,000 acres of farmland were irrigated. Livestock was a major product. The valley’s relatively high elevation (ranging from 3,600 to 4,300 feet), short growing season (150 days), alkaline soil, and limited access to markets constrained its agricultural potential. Census data reveal that the valley’s farms were smaller and had lower output on average than did their counterparts in similar rural counties in the Great Basin of eastern California and western Nevada.

Los Angeles sought the water because its meager rainfall and limited local supplies from the Los Angeles River watershed were insufficient to accommodate the city’s growth. Thanks to Owens Valley water, the city had grown from 250,000 people in 1900 to more than 2,000,000 by 1930, and land values climbed in the semi-arid San Fernando Valley just north of Los Angeles. The water from Owens Valley was transported via the Los Angeles Aqueduct. Constructed between 1907 and 1913, the aqueduct was one of the nation’s largest public works projects at the time, second only to the Panama Canal. Once a farm was bought, at least some of its water was released to flow down the aqueduct to the city, and the farm was leased back, in some cases to its previous owners, to raise livestock. All in all, Los Angeles spent more than $18,580,000 through 1934 for agricultural properties in the Owens Valley and about $6,000,000 more for town parcels, which were purchased as compensation to owners who feared economic damages as the agricultural economy declined.

Contrary to the prevailing view, the purchase of Owens Valley farms by Los Angeles did not represent a decline in value. Census data reveal that, through the period of negotiations, land values in Owens Valley (Inyo County) rose by around a factor of 11 between 1900 and 1930, whereas land values in Lassen County, a comparable agricultural county in eastern California, only doubled during the same 30-year period. These data suggest that most of the rise in land values in Owens Valley was due to land purchases by Los Angeles, not to changes in agricultural commodity and livestock prices. Other census data and information from the California Board of Equalization reveal that Owens Valley farmers did better by selling their properties to Los Angeles than if they had stayed in agriculture; similar agricultural regions were reeling from the onslaught of the Depression that began in the 1920s.

Despite all the apparent benefits of the transactions, historical and contemporary assessments of the Owens Valley exchange are almost uniformly harsh. An article in the Economist (July 19, 2003) summarizes the general view: “farmers remain suspicious of the ‘Owens valley syndrome.’ . . . The ‘theft’ of its water . . . in the early twentieth century has become the most notorious water grab by any city anywhere. . . . The whole experience has poisoned subsequent attempts to persuade farmers to trade their water to thirsty cities.” What then, is the source of the notion of “theft” that characterizes most views of Owens Valley? A thorough re-examination of the bargaining records between the LADWP and landowners provides an answer to this question and insights for promoting contemporary water markets.
 

Conflict between Farmers and the City

The gloomy assessment of the Owens Valley transfer developed in the 1920s, as farmers attempted to pressure Los Angeles to pay higher prices for their lands by embarrassing the city with negative press. Later in the twentieth century these charges were embellished by critics of Los Angeles who opposed its growth (it had become a symbol of urban sprawl) and political influence and were concerned about possible environmental damages to riparian areas in the Owens and Mono Valleys as the city pumped groundwater. But in the 1920s, both farmers and city officials wanted the negotiations to succeed. After all, the city’s growth depended on the region’s water; thus the Water Board was anxious to complete agreements as routinely and quickly as possible. Farmers, in turn, saw the city’s offers as an opportunity to sell their marginal farms at a time of growing agricultural distress.

The bargaining history between landowners and the Water Board reveals three key factors contributing to contentiousness and outright hostility. These problems were especially prevalent after 1923, when the city decided to buy as much irrigated acreage as it could, in response to severe droughts and unexpectedly rapid population growth. The three factors were bilateral monopoly, third-party effects on the neighboring communities, and disputes over property valuation. These are standard problems in complicated commercial exchanges of this sort; in negotiations over water and other natural resources, all three can impede the development of markets.

The disputes in this case were over the value of land and water both in Owens Valley and in Los Angeles. Each party wanted to direct negotiations to the values that were most advantageous. The Water Board wanted to use Owens Valley agricultural values in determining prices, whereas landowners wanted to use Los Angeles land and water values.

Agricultural land values in Owens Valley typically were much lower than either urban or agricultural land values in Los Angeles. It seemed only reason- able to Water Board officials to compensate farmers for what they could earn in Owens Valley farming. But the farmers saw that thousands of people were flocking to Los Angeles and that land prices there were booming—all made possible by Owens Valley water—and they wanted a share of those riches.

There were also disputes over how to value individual properties. The valley contained more than 800 farms, each differing greatly in inherent fertility, access to water, topography, and size. The valuation problems were quite similar to those faced in real estate markets today, but with few previous sales, there was little comparable price information on which to base offers. Disputes were the natural outcome. To assemble offering prices, the LADWP set up a special Appraisal Committee of three leading citizens of Owens Valley. But even this did not resolve disagreements about some key properties. Agreement was also complicated by questions of how much land and water Los Angeles would ultimately seek in Owens Valley. On the one hand, the city’s growth was exceeding expectations and unpredictable droughts were recurring in the region, encouraging farmers to hold out for higher prices. On the other hand was the possibility that the Water Board would eventually have enough land and water and would not need to buy more property. Both parties faced uncertainties.

Disputes over valuation took place, at least for some properties, within a bilateral monopoly context. On one side was the Los Angeles Water Board, generally the only purchaser of Owens Valley lands and water rights. On the other side were three sellers’ pools that colluded in their price negotiations. Pool members, who held out the longest before agreeing to sell, mobilized opposition in the valley to board offers and were implicated in the periodic dynamiting of the aqueduct, which attracted local and national press attention.

Bilateral monopolies are one of the most difficult bargaining settings for markets. They are characterized by indeterminate pricing outcomes because they depend on the relative bargaining power of the parties involved. Further, negotiations often break down or take a long time to complete or both. Small wonder that bargaining became so acrimonious.

As Los Angeles purchased properties in Owens Valley and took them out of irrigated agriculture, complaints arose that the sales were hurting the local economy and damaging property values in the five towns. The magnitude of the effects was disputed by both sides and certainly would have been difficult to separate from the broader agricultural depression. Data on property values again suggest that the negative impact of Los Angeles’s purchases was probably quite small. Nevertheless, in the end, the city purchased virtually all the town properties between 1931 and 1934 but paid pre-Depression prices for them as recommended by a mediation board.

Ultimately, after lengthy and rancorous negotiations over the most valuable properties, the LADWP secured almost all the private land in Owens Valley. Although the evidence indicates that both parties did well in the exchanges, with no record of the often-claimed economic devastation, the charge of water theft remains a hallmark of the story.
 

Debunking the Myth of Owens Valley

Part of the notion of theft that persists in popular discussions of Owens Valley arises from the farmers’ inability to capture more of the value of their water holdings as they negotiated in an agricultural land market. They wanted prices that more closely reflected water values in Los Angeles, not in Owens Valley agriculture. But their “cartel” was not strong enough. Farmers were able to negotiate higher land prices than their counterparts in other counties were getting, but they couldn’t obtain prices that fully reflected the higher value of water in Los Angeles.

Another part of the notion of theft comes from the huge imbalance in the distribution of the total gains from trade. Los Angeles received the lion’s share because water was so much more valuable in the city than in Owens Valley and because the farmers, even with their sellers’ pools, were unable to capture more benefits.

Market trades tend to go smoothly when the benefits are shared reasonably equally. When the gains from trade are very large, however, as in the case of Owens Valley, distributional outcomes become critical in assessing the outcomes. Its history might have been viewed differently, had the differences been smaller.

Fairness in compensation is important in contemporary water markets. Valuation disputes, bilateral monopoly factors, and alleged third-party effects complicate negotiations between representatives of urban areas and rural irrigation districts today. The long and tortuous record of negotiations in Owens Valley demonstrates the importance of resolving distributional conflicts in water transfers early so that market trades can take place. A variety of the mechanisms are available to smooth transactions. One is the upfront agreement by all parties to dedicate a portion of the value of a trade to address disputes but not allowing them to impede the exchange. The benefits of reallocating water are so large that the financial resources are there to resolve these issues.

The lessons of Owens Valley can also be applied to other water trades, such as the growing effort to protect in-stream flows in the West. As concern grows about protecting aquatic life (including endangered species), private groups and public agencies have begun to purchase water rights from farmers to keep more water in streams and rivers.

Because these trades are voluntarily negotiated, they avoid the political rancor associated with arbitrary regulatory or judicial rulings. Timely market exchanges can smoothly and accurately re-allocate the appropriate amounts of water. Furthermore, if property rights are fully specified, all parties can benefit from the transactions. Nevertheless, as the Owens Valley story makes clear, the development of in-stream flow trades will likely encounter the interrelated problems of valuation, bilateral monopoly, and third-party effects. Attention to them is important in helping markets develop to allocate the West’s most critical resource: water.



Special to the Hoover Digest.

Available from the Hoover Press is Free Markets under Siege: Cartels, Politics, and Social Welfare, by Richard A. Epstein. To order, call 800.935.2882 or visit www.hooverpress.org.