For generations, economists have viewed markets as the gold standard of efficiency, assuming resources naturally flow to the people who value them most. But new research from the University of Miami Patti and Allan Herbert Business School suggests that assumption can break down when participants cannot afford to compete on equal footing.
In practical terms, the study found that poorer farmers were often unable to buy the water they needed at the moments their crops needed it most, while wealthier farmers could outbid them regardless of actual agricultural need.
In a recent paper published in the Review of Economic Studies, Javier Donna, associate professor of economics and holder of the Jeffrey L. Bewkes Family Endowed Chair at Miami Herbert and co-author Jose Espin Sanchez, assistant professor of economics at the Yale University, examined centuries-old water markets in southeastern Spain and uncovered a surprising result: replacing a free-market auction system with fixed quotas increased agricultural productivity by about 6 percent.
"We went into this expecting to confirm the conventional wisdom that markets outperform quotas," Donna said. "Instead, the data kept telling us the opposite story."
The paper, "The Illiquidity of Water Markets," analyzes irrigation systems in Mula, a farming community in Spain's arid Murcia region, where water had been allocated through public auctions dating back to the 13th century. Farmers gathered weekly to bid on irrigation rights, with wealthier landowners often dominating the process.
"What we found was very human," Donna said. "These poor farmers simply did not have enough cash to compete in the auction when they needed water the most. The wealthy won the auctions by default, not because they valued the water more, but because they had deeper pockets."
The researchers discovered that wealth inequality, rather than differences in agricultural need, drove many of the market outcomes. Farmers were growing the same crops under the same environmental conditions, meaning the trees required similar amounts of water regardless of who owned them.
"The demand for water was determined by the biology of the trees, not the wealth status of the farmers," Donna said. "That allowed us to identify which farmers were truly constrained financially, rather than simply preferring to buy less water."
Poor farmers adapted strategically, purchasing water before and after critical growing periods when prices were lower, anticipating they would be unable to compete once auction prices surged. Wealthier farmers, meanwhile, were able to purchase water during the most important periods of the season.
"That stark pattern was really what opened our eyes," Donna said. "Markets were not working the way they should. These farmers were doing the best they could under the circumstances."
Eventually, Mula abandoned the auction system entirely, switching to quotas in 1966. The shift mirrored systems already used across much of southeastern Spain and became central to the researchers' analysis of how financial inequality can distort market efficiency.
Donna believes the findings carry important implications far beyond one Spanish farming community.
As water scarcity intensifies globally, policymakers increasingly rely on markets to allocate limited resources. Donna said the study highlights the importance of understanding who can realistically participate in those markets.
"Markets can be a powerful tool," he said. "But when participants face financial constraints, markets do not necessarily allocate resources to the most productive users. They allocate them to whoever has the most cash on hand."
The findings may become increasingly relevant as drought conditions worsen across regions like the American West, where states continue debating how to manage shrinking water supplies.
"The conditions that caused markets to fail in our setting are likely to become more common in the future, not less," Donna said. "Scarcity increases prices, and higher prices widen the gap between financially constrained and unconstrained participants."
Donna also sees parallels between water markets and modern digital markets shaped by artificial intelligence and algorithmic pricing systems, a growing focus of his current research.
"Technology does not eliminate the underlying economic frictions," he said. "If access to these systems remains unequal, the same kinds of exclusions can persist."
The project took more than a decade to complete. Donna and Espin Sanchez began the research while both were doctoral students at Northwestern University, spending years digitizing centuries-old auction records, tax rolls, and financial archives by hand before conducting the economic analysis.
For Donna, the study ultimately reinforces a broader lesson about the limits of markets when inequality shapes participation.
"When everyone can participate equally, markets can work beautifully," he said. "But when people cannot participate on equal footing, those differences matter a great deal."
