Evolving markets for water

Jeff Bennett and Alan Moran

Jeff Bennett is a Professor at the Australian National University and editor of a newly published book, “The Evolution of Markets for Water”. 

Alan Moran is Director Deregulation at the Institute of Public Affairs. 

Water restrictions in towns and cities around Australia make striking headlines but only 15% of Australian water is for domestic or industrial use.  Even though Australian rainfall is irregular, there is plenty of scope to satisfy this demand. . 

Irrigation water is another matter.  Having water at the right time and place means enhanced agricultural productivity.  Hence, demand has grown for irrigation water and its associated water storage and diversion schemes. By 2001, irrigated agriculture was using 16,660 gigalitres of water per annum and generating a gross value of $9,618m. However, over the past decade, the pace of this growth has been overshadowed by increasing competing claims for ‘environmental flows’ in rivers. Together the two factors have created a scarcity of water.

But scarcity is nothing special in our society. The trading in markets of rights to all sorts of scarce resources is fundamental to our highly successful system of social coordination.

However, a good deal of debate remains over the suitability of the market mechanism when applied to the allocation of scarce water resources between competing uses. This is despite the extent of the different values of water both over time and space. Such large differences imply that strong gains are available to society from trading water in markets.  Water trading to be truly effective requires private ownership and a regulatory relaxation over water resources.

Yet governments are seeking to maintain control over water resources.  This allows government (and those advising government) to hold onto the ability to achieve their individual goals through making allocations to vested interest groups. Their ambitions in this direction are aided by fundamental characteristics of water that involve “transaction costs” in defining, defending and trading property rights to water.

For instance, water is in many circumstances, a fugitive resource in that it moves through the environment in ways that can be difficult to trace. In addition, some of the uses of water produce public goods - namely those associated with environmental protection - which by definition are non-excludable and therefore impossible, or at least extremely costly, to defend against use by those who do not pay.

In spite of these difficulties, there are powerful arguments in favour of using markets.  Without them, the incentive structures facing politicians and their advisers create transaction costs of a different sort.  Without a market in water in which alternative allocations are priced, there is little possibility of politicians and their advisers achieving efficiency in water allocation from a societal perspective.   In the absence of a water market, regulatory decisions have no measure to determine their true costs and hence a particularly fertile field emerges for bureaucratic empire building with all the dead weight costs that entails. 

Even if politicians and their advisers could be relied upon to make decisions on water that are not dominated by personal motivation but are in the best interests of the wider community, it remains doubtful that they could allocate water efficiently. This is because of the high – often impossibly high - costs faced by the state in collecting and processing in a timely fashion, the sort of information required to ensure the most efficient uses of water at any particular time.

Among the pieces of information regulators would need to assemble to do the job routinely managed by markets is knowledge of the value of different extractive uses of water available from the production of irrigated crops and non-extractive environmental values such as the existence values arising from the protection of riverine ecosystems. There are obvious complexities involved in estimating the latter, non-marketed values but even the task of estimating extractive values in real time is by no means straightforward given government’s difficulty in finding out the real values that private producers place on their use.

The current evolutionary trend in Australia is toward the use of markets. Numerous reforms are underway or proposed in that direction. However ‘restraints to trade’ in water rights remain, particularly between urban and rural uses and between extractive and environmental uses. The process by which water is assigned for environmental flows remains arbitrary and subject to rent seeking. Governments are still reluctant to subject investments in water infrastructure to full cost benefit scrutiny. Removing these uncertainties over property rights and the scope for regulatory intrusion is essential to enable greater environmental and economic wealth to be generated from what water resources we do have.