The history of irrigation organizations during the late nineteenth and early twentieth centuries in the arid and semi-arid American West reveals the important role of experimentation in determining the institutional forms that evolved. The legal framework was such that a wide variety of bottom-up organizations developed to deal with transaction cost problems. Contracting was complicated by asset specificity, potential spillovers between users, free-riding, and holdout problems. Asset specificity on the part of both farmers and irrigation infrastructure owners should have led to vertical integration with a single firm owning both the farmland and the infrastructure. However, the differing economies of scale between capturing and delivering irrigation water and farming meant that vertical integration would have resulted in costly operations. Instead of vertical integration or the separate ownership of farms and irrigation infrastructure, western farmers sought out intermediary institutions. In some cases, simple contracts among a few farmers were sufficient to divert water from streams and to carry it to crops. In other cases, a developer would form a commercial irrigation company, buy a large block of land, install irrigation infrastructure, and then sell off farms. However, the commercial irrigation company did not provide solutions to transaction cost issues; instead, it was fraught with transaction cost problems that undermined its usefulness. Mutuals, both incorporated and unincorporated, allowed farmers to contract with other farmers to own and operate irrigation facilities. Irrigation districts, a form of localized government with coercive powers, were authorized in all of the western states. These districts became another significant form of irrigation organization.
INTRODUCTION II. THE TRANSACTION COSTS OF IRRIGATION III. COMMERCIAL IRRIGATION COMPANIES AND THE PROBLEM OF TRANSACTION COSTS IV. TRANSACTION COSTS OVERCOME--MUTUALS AND IRRIGATION DISTRICTS A. Unincorporated Mutual Associations B. Mutual Irrigation Companies 1. The Nineteenth Century Revolution in Corporate Law 2. The Institutional Form of Mutual Irrigation Companies 3. Mutual Irrigation Companies and Transaction Costs C. Irrigation Districts 1. The Formation of Irrigation Districts 2. The Financing of Irrigation Districts 3. Irrigation Districts and Water Rights 4. Irrigation Districts and Transaction Costs.. V. CONCLUSION I.
Aridity is a defining characteristic of the American West, and the application of water to land is a central theme in the history and development of the seventeen coterminous western states. "As late as 1875, W.B. Hazen, an army officer who served in the West, claimed that all the land between the hundredth meridian and the Sierra Nevada was uninhabitable and that 'emigration to these places known not to be arable, be emphatically discouraged.'" (1) Others were more optimistic about the settlement of the West if the problem of irrigation could be solved. In 1896, the legal scholar William P. Aiken wrote:
The economic future of the far west is largely dependent on a practical solution to the problem of irrigation. Millions of acres lie there sterile and lifeless, yet with all the elements of fertility locked up in the soil, and with sunshine and a climate favorable to every kind of agricultural production. The nimble jugglery of the statistician does not enable one to grasp the situation. Square acres of maps and huge columns of figures convey but a dim impression of the urgency of the problem. Only the traveler who has passed over the vast solitudes and witnessed the transformation wrought here and there by some unknown Aaron of the wilderness can appreciate the enormous forces of nature waiting for a deliverer. (2) As the three million acres of land that were under irrigation in the seventeen coterminous western states in 1890 (3) grew to over forty million acres by 1978, (4) the "deliverer" of irrigation water that Aiken thought was necessary to develop the West had been found. As the decades immediately before and after the turn of the twentieth century revealed, the process of capturing and delivering water required a variety of institutional forms and legal arrangements. The legal structures available at the time allowed for different organizational experiments, some successful and others not, in the form of private and public, small scale, local institutions that captured and distributed water and managed the application of water to land. Private institutions included commercial irrigation companies, unincorporated mutual associations, and mutual irrigation (or ditch) companies. The primary public institution was the irrigation district. (5)
With these forms of organization, the settlers of the West applied new institutional solutions to underlying economic problems. Due to the lack of rain, farming in the West without irrigation has never been economically viable. In addition to the challenges created by geography, the vagaries of the weather, and the fluctuating markets for agricultural products, farmers also contended with fundamental economic problems in organizing production. These more fundamental problems arose because farms required a certain scale while irrigation facilities usually required a larger scale. The different economies of scale (6) dictated different optimal sizes for organization and led to transaction costs (7) that had to be overcome by farmers and the suppliers of irrigation water. These costs ranged from vertical integration costs (8) associated with non-optimality (9) of size to contractual costs created by hold-up problems and opportunistic behavior. (10) Each of these problems represents a Coasean property rights problem in which transaction costs can prevent contractual solutions from addressing all the costs and benefits of a relationship. (11) The Coasean solution to a Coasean property rights problem is the firm, (12) and the settlers of the West turned to the firm, or, in the case of irrigation districts, firm-like structures, to reduce transaction costs associated with irrigation.
Commercial irrigation companies, mutual irrigation companies, and irrigation districts represented legal innovations that were adapted to the need for irrigation water to farm the West. By using private, corporate forms of organization in the late nineteenth and early twentieth centuries, the developers and farmers of the West took advantage of the contemporaneous revolution in corporation law that resulted in the modern business corporation. (13) By forming irrigation districts, farmers also pioneered the use of local government special use entities that are prevalent today. (14) Thus, the agricultural development of the West illustrates both an adaptation of farming techniques and technologies to an arid climate and geography and the adoption of new legal entities to solve the transaction costs of organizing the capture and delivery of water for agricultural purposes.
More recently, the institutions that farmers organized to overcome transaction costs in irrigation over a hundred years ago have been analyzed in the context of modern water transfers. (15) Since these institutions were designed to deliver water effectively to groups of farmers within the organization, most of these institutions allowed for efficient intra-organization transfers of water to meet changing demands. However, when irrigation institutions were formed, few people believed that the highest valued use of water rights would ever be outside of agriculture or even the organization itself. Little thought was given to structuring the institutions so that water owners could easily respond to changing market conditions and move water to other uses, such as developing profit-sharing mechanisms among the members of the institution for water transfers by individual members. (16) Thus, the historical development of irrigation institutions has resulted in high transaction costs for water transfers to municipalities and other users outside of the original organization.
Ultimately, an analysis of the influence of irrigation institutions in contemporary internal and external water transfers is enhanced by an understanding of the reasons why the institutional forms were created in the first place. This article analyzes the evolution of irrigation institutions in the American West in the late nineteenth and early twentieth centuries. Part II describes the transaction costs and property rights framework that led to the irrigation institution as the solution to the problem of organizing the capture, delivery, and management of water for agricultural purposes. One underlying assumption is that in situations with a high degree of residual claimancy (17) on the part of decision makers, the institutional form, such as the size and nature of firms and contracts, will be one that maximizes the wealth of the participants, net of transaction costs. (18) The result is viewing the rules of the game through "the lens of contract." (19) Part III illustrates, through the example of commercial irrigation companies, how transaction costs made some organizational forms unworkable over time. Part IV describes the different types of irrigation institutions created by western farmers to solve transaction cost problems and discusses how different legal structures addressed these difficulties.
THE TRANSACTION COSTS OF IRRIGATION
Transaction costs are part of the costs of defining and enforcing property rights. The firm is an organization created to reduce transaction costs. (20) Several types of transaction costs influenced the development of the type of organizations used by settlers in the American West to apply irrigation water to land: asset specificity (21) and opportunism, holdout problems, and free-rider problems. (22) These transaction costs arose from the arid conditions that the settlers of the West encountered...