Recent agroeconomic studies in water-scarce countries such as Spain, Australia, Saudi Arabia, and Israel have revealed the economic viability of irrigating high-value crops with desalinated water. However, the worldwide growth of large-scale desalination capacities is primarily designed to resolve urban-water scarcity, disregarding the impact of desalination on irrigation-water salinity. We develop a dynamic hydroeconomic programming model where infrastructure capacities and allocations of water quantities and salinities in a regional water distribution network are endogenous. We show that subsidizing desalination is socially warranted because the associated reduction in irrigation-water salinity is an external effect of water consumption by all water users. Empirical application to the entire state of Israel indicates that large-scale desalination of seawater and treated wastewater for irrigation is optimal. This result stems from the large share of irrigation-intensive salinity-sensitive high-value crops, motivated by Israel's policies to support local agriculture. Ignoring salinity results in a 45% reduction in desalinated irrigation water, a 29% reduction in farming profits, a 250% increase in water suppliers' profits, and an average deadweight loss of $1,200 a year per hectare of arable land.

Israel’s water and vegetative agriculture sectors are interdependent, as the latter constitutes the solution for wastewater disposal. We employ a dynamic mathematical programming model that captures this interdependence for evaluating the economic damage of irrigation water salinity under two strategies of blending water sources with different salinities: field blending, which enables farmers to assign water with a specific salinity to each crop, and regional blending, under which all crops experience similar water salinity. Relative to field blending, the buildup rate of desalination under regional blending is slightly expedited; nevertheless, reallocations of water sources across sectors and crops increase the average irrigation water salinity, and the overall welfare decreases by USD 0.08 per cubic meter of irrigation water—about 20% of the water’s average value of marginal product. Salinity-sensitive crops will face the largest per hectare production reduction if regional blending replaces field blending; however, the combined variations in the prices of irrigation water and agricultural outputs may motivate farmers to move irrigation water to these crops. Under equilibrium conditions in the two sectors, a 1% increase in the average salinity of the irrigation water supplied to a region reduces the value of the marginal product of that water by 2.4% and 1.6% under field and regional blending, respectively.

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