Are Water Markets Effective? Despite implementation challenges, water markets hold promise

As forces of climate change and ecological and environmental stressors continue to strain water access in the world’s drier regions, policymakers have begun to reassess the efficacy of traditional water conservation efforts. One new proposal is the implementation of water markets – systems in which allocations of water below a set cap are traded between parties in a similar fashion to the carbon cap-and-trade systems. In a 2014 paper published in Water Policy, researchers examine the benefits and challenges of using water markets as an alternative to standard regulatory approaches to conservation.

The authors analyze seven water market regions across the globe. In the United States, they analyze the Edwards Aquifer in Texas, the Northern Colorado Water Conservancy District, the Columbia River Basin in the Pacific Northwest, and California’s Central Valley/San Joaquin River. Internationally, they evaluate the Murray-Darling Basin of Australia, Mexico’s Santiago River Basin, and the national market of Chile. Each is evaluated based on its relative success in limiting total water use, protecting ecosystems and species, and spurring shifts in water use towards increased economic productivity.

By examining each market, the authors highlight specific challenges to designing and effectively implementing water markets. For instance, the Edwards water market was formed to protect endangered species by capping water consumption. However, a series of legal challenges to the program forced the issuance of water permits tens of millions of cubic meters above the initial cap. This outcome could have been environmentally damaging had most of the permits not gone unused. In 2007, the Texas legislature raised the cap and changed the market from a system of permanent water rights exchanges to a system of exchanging rights exclusively during drought periods. The changes are expected to be sufficient to protect the endangered species, but the authors argue that transaction costs are inflated by a lack of price transparency and perhaps poor communication between rural water users and urban suppliers. Such complications limit the efficiency of the Edwards market and would likely afflict similar markets in which rural and urban water users bargain for rights.

The expense of transporting water is another potential challenge to successful implementation of water markets. Water is heavy and transportation costs are thus high relative to the value of water to users. As a result, prices are often inflexible, and trades are often highly localized or restricted to areas with well-developed water infrastructure.

Different rights classifications also complicate the successful implementation and analysis of markets. For example, in addition to permanent and temporary rights, Australia’s water markets offer rights with varying levels of allocation “security” for buyers. While these kinds of options allow markets to function more efficiently, the authors point out that options can also make market design difficult, requiring a “non-negligible degree of financial sophistication” in order to make optimal market decisions.

In spite of the difficulties, the authors believe that well-designed water markets are promising tools to augment existing water conservation efforts. Additionally, they suggest that markets could perform the supplemental function of more efficiently allocating water to economic sectors that use it most productively. The agricultural sector, for instance, uses more water relative to its economic productivity than do other sectors. In Australia’s Murray-Darling Basin, the agricultural sector is 60 times less productive than the manufacturing sector and 16 times less productive than the mining sector in terms of employment per megalitre of water. In Mexico’s Santiago Basin, the agricultural sector consumes 82 percent of available water while accounting for only five percent of the region’s GDP.

Over the past few decades, decreased agricultural employment in regions where water markets have been implemented has led to the gradual reallocation of water rights from the agricultural sector to other more productive sectors. The authors argue that water markets can enable such productive inter-sector trades up to a point. Regions with greater access to food imports will be more likely to allow free inter-sector trades while other regions could use water markets to introduce taxes or limit water transfers away from agriculture to protect food supplies and rural lifestyles.

There are significant challenges to implementing water markets. However, the overall potential economic and ecological benefits of water markets arguably make them worthwhile. As stressors like climate change threaten to exacerbate the mismatch between water needs and availability, water markets hold promise as a means of improving economically efficient and sustainable water use.

Article Source: “Water markets as a response to scarcity“, Debaere et al, Water Policy, 2014. 

Feature Photo: cc/(Andrew W. Sieber)