Hometown U: Electronic water sales in Chile are examples of experimental economics

Kathleen McCoy

After living through the unintentional financial "experiments" that pumped up the U.S. housing market in the early 2000s, only to smash it like a melon on pavement by 2007, you might think we'd be frightened by the idea of more "experimental economics."

But in fact, a relatively new field by that name studies the very behaviors that, among other things, lead us to create and fall for market bubbles. There is so much human behavior behind experimental economics that it's sometimes described as psychology with money.

Elmer Rasmuson funded a special chair in economics at UAA in 2001. Vernon Smith, a Nobel Prize winner specializing in experimental economics, held it from 2003 to 2006. Others, including experimentalist and resource economist James Murphy of UAA and psychologist Robert Kurzban of the University of Pennsylvania, have served along the way. A new experimental economist, Todd Cherry from Appalachian State in the Blue Ridge Mountains of North Carolina, will take the seat next fall.

Recently, I watched a member of the team, which is housed within the College of Business and Public Policy, pitch his research to undergraduates. Among professor Jonathan Alevy's curious pursuits: setting up an electronic water market in Chile, and figuring out if humans take more or less economic risk when days grow longer. The results aren't all in, but he's got enough data to talk about each project.

First, why an electronic water market in Chile? While it seems remote from Alaska, if you enjoy Chilean wine, it has likely been touched by Alevy's water market.

The project followed Alevy to Alaska from his graduate work at the University of Maryland, where he earned a doctorate in agricultural and resource economics in 2006. A fellow student from Chile, Oscar Cristi, had dissertation questions about Chilean farmers and how they handle risk. Alevy and Cristi pondered the questions together, and eventually Cristi tapped Alevy for help.

The farmers live in the Limari Valley in central Chile, north of Santiago. This is home to well-known Chilean vineyards and other perennial crops. Annual crops, like wheat and corn, also grow here. The area is dry and getting dryer. Rainfall, and especially the lack of it, represents considerable risk to farmers.

Local water associations already allocate water from storage dams to farmers, based on each farmer's water rights. If farmers don't need all their water, they can sell it to other farmers who do.

Until recently, water transactions happened through informal face-to-face negotiations between farmers who know each other. A whiteboard at the water association might include scribbles like a phone number and note, "I need water."

Alevy and Cristi wondered if a seasonal electronic market where farmers could offer and bid for extra water as part of a large pool of traders -- much like a stock market -- would optimize the value of water.

Why worry about water value? When a resource is undervalued, it tends to be wasted. Knowing its real value may motivate a farmer to sell what he doesn't need. Or in severe drought conditions, a farmer of annual crops might choose to forgo planting for a season and sell his water to a farmer trying to protect an investment in perennial grapes. This could improve the local economy overall.

If a perennial farmer fails to find enough water on the market, that's a clear indicator that the valley is over-planted with perennials.

Further, without more information, how can farmers even know the value of water? Cristi had evidence that when farmers sell water face to face, prices are volatile. Think of buying Apple stock from a friend with no information about its price on the NYSE. A market helps set value and make that value transparent to all.

Alevy and his Chilean colleagues were warned that farmers might be suspicious. Would they warm to the idea of bidding and selling water in an impersonal marketplace?

The short answer is, they did. The pilot market is in its third year and serves numerous farmers, including some of the largest producers. In addition to setting the real value for water, the market has introduced safeguards to ensure that when a farmer buys water, he gets it, much like the recent Dodd-Frank reforms try to make U.S. markets more accountable to consumers.

Now, to the question of whether we're more prone to take economic risks during the long days of an Alaska summer. Or, as Alevy asks, "Do we enter the market differently," depending on the seasons.

This is a new area of study, but data from financial markets do suggest that length of day affects us. An existing study of people with Seasonal Affective Disorder (SAD) in Canada showed telling results.

"Those who have SAD seem to shift toward being more risk averse in darker times, going into fall and winter," Alevy said. Conversely in spring, "they seek more risk as the light returns."

This financial market data could have implications for the broader population.

That's something I'd like to know a whole lot more about. Stay tuned. Alevy just won a campus Innovate Award to stimulate further investigations.

Kathleen McCoy is an electronic media specialist at UAA, where she highlights campus life through social and online media.

Kathleen McCoy
Hometown U