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For centuries, irrigation communities in south-eastern Spain were socially stable and economically efficient. In this article, we show how these self-governing institutions persisted by resolving conflicts over scarce resources with flexible punishment for water theft. We argue that variable penalties for violating irrigation rules provided social insurance to farmers during droughts. We develop a dynamic model in which judges trade off crime deterrence and social insurance, and test its predictions using a novel dataset on water theft in the self-governed irrigation community of Mula, Spain, from 1851 to 1948. For the same offence, we show that recidivists were punished more harshly than first-time offenders. When the defendant was wealthy, as indicated by the honorific title don, or the victim was poor, judgements were stricter.