A theoretical model of water and trade

•A theoretical model that captures key tradeoffs in water resources use is presented.•Conditions under which trade liberalization impact domestic water use are shown.•A water tax and subsidies to agricultural capital are policy mechanisms to reduce water use.•Risk in water supplies impacts farmer decision-making, reducing water use.

Water is an essential input for agricultural production. Agriculture, in turn, is globalized through the trade of agricultural commodities. In this paper, we develop a theoretical model that emphasizes four tradeoffs involving water-use decision-making that are important yet not always considered in a consistent framework. One tradeoff focuses on competition for water among different economic sectors. A second tradeoff examines the possibility that certain types of agricultural investments can offset water use. A third tradeoff explores the possibility that the rest of the world can be a source of supply or demand for a country’s water-using commodities. The fourth tradeoff concerns how variability in water supplies influences farmer decision-making. We show conditions under which trade liberalization affect water use. Two policy scenarios to reduce water use are evaluated. First, we derive a target tax that reduces water use without offsetting the gains from trade liberalization, although important tradeoffs exist between economic performance and resource use. Second, we show how subsidization of water-saving technologies can allow producers to use less water without reducing agricultural production, making such subsidization an indirect means of influencing water use decision-making. Finally, we outline conditions under which riskiness of water availability affects water use. These theoretical model results generate hypotheses that can be tested empirically in future work.