Designing liquid markets
Kidney exchange or water markets - optimal allocation is a math problem!
Sometimes, just sometimes,
The solution to big problems is easy;
And other times,
It's a string of easy solutions-
Interlocked with some hard thoughts.
Here’s today’s problem requiring some hard thought:
Everyone has two kidneys. Most of them can lead a healthy life with just one. Which means, there are enough people, living and deceased combined, capable and willing to donate a kidney.
Still, thousands die waiting for a kidney transplant. Why?
Let’s explore John’s case. John’s kidney function is deteriorating and he’s on a frequent dialysis regime. His doctor suggested kidney transplant a year ago but he’s not found his match until now. This year, his spouse and his best friend offered to facilitate the transplant, but to John’s bad luck - none of them are a good match. Now, he has no option but to wait in the long digital queue in order to find a compatible donor. Turns out, the wait may be longer than his length of life.
And just like that, thousands die waiting for a transplant to happen.
Can this be avoided? Yes.
Let’s see what we can do to help John. If you remember, his spouse and his friend got themselves tested for donor-patient compatibility. The result was, ofcourse, not compatible. So both of them were sent home empty handed. In the same hospital, there’s another patient named Ali waiting for a kidney transplant. His spouse too, is not compatible to match with Ali. Both Ali’s and John’s spouses are in a similar state of helplessness.
The doctor is smart. Upon evaluating internal data, he’s able to figure out that Ali’s spouse can donate to John, and John’s spouse can donate to Ali. Donor-patient compatibility, finally! So four of them strike a deal, the patients get the transplant done, and at the end of the day, the doctor saves two lives instead of zero.
Digging deeper, this model can be scaled. Enabling live-donors to facilitate kidney transplant can save thousands of lives each year.
But designing a market mechanism for matching donors to the patients in need is not so simple. It requires cooperation from multiple institutions to expand the database, which in-turn increases the chances of matching with a compatible donor. It also has to take into account varying factors, some factors being hard to quantify - favouring young patients or the older ones, to favour comparatively healthy patients or the ones which have waited longer, incentive for living donors to donate their kidney etc.
IRL, Prof. Alvin Roth and his colleagues solved this problem by enabling matches between donors and patients, two-way and also three-way matches! Kidney exchanges are now a real thing. Life saver! Turns out it was a maths problem.
Another maths problem
Another problem that we face today is the freshwater availability problem. Could you argue that there just isn’t enough water on Earth for us to drink and use? I don’t think so.
Water is a resource which is shared by many, but owned by none, which makes it a perfect target of overexploitation. For example, even during a megadrought, one out of every three farmers in California farmed acres of alfalfa, the most water-intensive crop grown in the valley. Was that the most optimal use of water?
Optimal allocation of water through market mechanisms can solve the freshwater shortage.
This too is a maths problem.
Similar to the factors associated with kidney transplant, developing a mature market for water will be constrained or dependent on multiple, and sometime hard to quantify factors:
Aggregation of tradable water resources
Market participants and trading arrangements for water
Distance between source of water and usage location
Accounting for high storage & transportation charges
Infrastructure availability for storage and transportation
Mechanism for determining the price of water
Quality and quantity of water being traded
Availability of public information on water availability and quality
Role of centralised institutions to develop trust in the system and making changes to the system that reflect ground-realities front time to time
Aligning incentives for market participants
In today’s blog post, I thought we’ll discuss some of the types of functioning water markets:
Water Rights Trading & Water Futures
In regions such as California of the USA, or the Murray Darling Basin of Australia, water rights trading is a common practice. Essentially, water-use entitlements are stripped off from land entitlements. For use of water above the annual allotments or permits, water rights have to be purchased from sellers of water rights. The markets have various participants - including farmers, NGOs, municipalities, etc. who transact with each other. Water futures, on the other hand, are derivatives to hedge against the price movements of water rights, just like coffee or soya bean futures.
Water Quality Trading
Here is where the maths gets a bit tough. Water quality trading is by design, a localised market for pollution permits. It helps maintain the water quality in the freshwater sources and thus, ensure future availability of clean water.
Let me explain, think of a beautiful river flowing through your neighbourhood. Growing industrialisation along the river banks is raising concerns of water pollution in the community. The discharge of pollutants in the river is capped, and should be regulated to maintain the water quality of the river. In a water quality trading program, the participants in the same watershed - like farmers, industries, sewage treatment plants etc. will earn, buy and/or sell credits amongst themselves so that the overall pollutant discharge in the river can be maintained within the regulatory limits.
Water quality trading may lead to significant cost savings too. It is based on the fact that different participants in the same watershed encounter different costs to control the same pollutants. Consider setting up a water treatment plant, it’s a costly affair. But what if the same amount of nutrient reduction could be achieved by the farmers employing best practices and deploying restoration projects along the water source. The pollutant-emitting industry could then just buy credits sold by the farmers. Overall, in the watershed, the same amount of pollution reduction was achieved at a much smaller cost.
Future of water markets
Designing market-oriented mechanisms to trade water is much more difficult than setting up markets for carbon credits. One ton carbon dioxide removed from the atmosphere in Columbia or in Iceland is still a ton less carbon dioxide in the atmosphere. On the other hand, water is a resource which requires localised solutions which take into account factors related to geography, community, ecosystem, costs, quality, etc. Attaining standardisation is tough, and as we know, standardisation attracts liquidity to the markets.
So will the water markets ever be liquid? There’s hope.
A push from regulatory authorities promoting participation in water markets can significantly boost liquidity as well as help achieve water security in the region. Countries which emphasise on efficient allocation, usage and treatment of water early on, will gain a significant advantage in the long run.
If you have any thoughts on designing water markets, please do write to us at dhanvi.oza@ctrlz.world. In the meantime, you can watch Mike Holmes build a net zero house which produces as much energy as it consumes.