bjornlund (2002)

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Aspects of water markets for developing countries:experiences from Australia, Chile, and the US

Henning Bjornlund and Jennifer McKay

Environment and Development Economics / Volume null / Issue 04 / October 2002, pp 769 - 795DOI: 10.1017/S1355770X02000463, Published online: 02 October 2002

Link to this article: http://journals.cambridge.org/abstract_S1355770X02000463

How to cite this article:Henning Bjornlund and Jennifer McKay (2002). Aspects of water markets fordeveloping countries: experiences from Australia, Chile, and the US. Environment andDevelopment Economics, null, pp 769-795 doi:10.1017/S1355770X02000463

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Aspects of water markets for developingcountries: experiences from Australia, Chile,and the US

HENNING BJORNLUND and JENNIFER McKAY1

School of International Business, University of South Australia, Adelaide

ABSTRACT. Water market reforms are being promoted by international organisations,such as the World Bank, and pursued within many developing countries. Actual experi-ences with water markets are limited and the opinions regarding the beneficial ordetrimental impacts diverse. It is therefore crucial to learn from the few functioningmarkets. Some of the longest operating, and most mature markets in the world, are to befound in Southeastern Australia. This paper examines the outcome of water trade inSoutheastern Australia and combined with US and Chilean experiences outlines somelessons for the introduction of markets in developing countries.

1. IntroductionWater reforms have been promoted widely during the 1990s by inter-national organizations such as the World Bank (1993), United Nations(Sitarz, 1993), FAO (1999), OECD (1989), and UNESCO (2000). Since waterreforms now are an official World Bank policy, they are an integral part ofnew projects in developing countries. Key elements of such reforms aremarket mechanisms and full cost recovery pricing. Actual experienceswith water markets are still sparse, and doubts about their beneficialimpact still exist among policy makers, water managers, and in academia.It is therefore imperative to learn from countries where markets have oper-ated for some years. Even though there can be no ‘right’ way of designingand implementing water markets, since such systems have to be designedwithin the local climatic, hydraulic, economic, social, and legal context,important lessons can still be learned.

Apart from Australia, water markets in two other countries are fre-quently mentioned in the literature. In the southwestern US, many states

Environment and Development Economics 7: 769–795 © 2002 Cambridge University PressDOI:10.1017/S1355770X02000463 Printed in the United Kingdom

1 Dr. Henning Bjornlund is a Research Fellow and a member of the Centre for LandEconomics and Real Estate Analysis and Dr. Jennifer McKay is Professor ofBusiness Law and the Director of the Water Policy and Law Group. The Land andWater Resources Research and Development Corporation in Canberra, Australiafunded this project until April 2001 and the Australian Research Council and nineindustry participants are funding ongoing research.

specifically allow water trade, and regulations set out the conditions forsuch transfers. However, water transfers are still relatively limited, andsettlements of related disputes are largely referred to the judicial systemmaking transfers expensive, time consuming, and uncertain (Huffman,1997). Also, strong urban and industrial demands have influenced marketoutcomes (MacDonnell, 1990). In Chile, markets are based on a neoclas-sical economic approach, backed by a judicial system with minimal stateintervention (Bauer, 1998). However, market activities in Chile are verylimited. Few empirical studies exist from either country about the oper-ation and impact of markets.

This paper will discuss the experiences gained in South Australia andVictoria in southeastern Australia, where markets have developed since1983, within a highly regulated and administrative environment, withstrong State-, Federal- and Basin-wide intervention, to safeguard socialand environmental values, with little resort to judicial decision making.This development has seen the gradual evolution of water market policies,resulting in less and less impeded markets. The development of the waterindustry has followed different patterns across jurisdictions. This hasresulted in different definitions of water rights and tradable systems,reflecting the variability of water use, ranging from intensive high valueuses, mainly horticulture and viticulture, through dairy to less intensiveand valuable uses such as cereal and mixed grazing.

The first part discusses the reasons for water markets and the expecta-tions of policy makers. The second part outlines experiences with watertrade in other countries while the third describes southeastern Australiaand the evolution of water market policies in Victoria and South Australia.The fourth part discusses the outcome of trade and the final part highlightsthe lessons learned and their implications for water markets in developingcountries.

2. Why water tradingWithin many developed countries, in semi-arid regions such as the south-western US and southeastern Australia, early developments sawsignificant investments in water infrastructure, to support human settle-ment of remote areas and boost national production. Today the watereconomy is in its mature phase (Randall, 1981). The costs of increasingsupply have risen sharply, and the political will to finance new projects hasdecreased, with concern for the environment and increased demand forpublic funds from other sectors of the society. During the mature phase,the emphasis is on making do with what we have, by reallocating it amongcompeting uses.

Developing countries have experienced the same need for reallocatingexisting resources due to increased demand, increased cost of newsupply and reluctance by financial institutions to fund new water infra-structure (Thobani, 1998). Reflecting this trend, the World Bank in 1993introduced a new water resources policy (World Bank, 1993). This policyhas, at its core, the treatment of water as an economic good, includingsuch features as property rights, full cost recovery pricing, removal ofgovernment subsidies, the use of market mechanisms, and calls for

770 Henning Bjornlund and Jennifer McKay

decentralization of water authorities and devolution of the managementof water resources.

Policy makers place considerable expectations on economic instruments,such as water markets, privatization and full-cost recovery prices.Academics, and among them foremost economists, have predicted con-siderable gains from trade. These are founded on the belief that:

• Tradable water rights give water a value separate from land, andprovide an incentive to use water more efficiently, since water savedcan be used to increase production or sold.

• Full-cost recovery prices will facilitate this process, by encouraging orforcing inefficient irrigators on degraded soils, as well as low valueusers, to sell their water, since they will not be able to sustain farming.High value producing irrigators, with efficient water use on suitablesoils will purchase the water. This will result in increased output fromthe water and thereby improve the financial position of the irrigator aswell as the local community. It will increase economic activity, sincehigh value crops are more labour intensive in the fields, transport, pack-aging, and processing. Gaffney (1997) said that when water isexpensive, less water is used to produce more value of crop, and thatareas with cheap subsidized water have more unemployed and peopleon social security.

• Reallocation by market forces reduces government costs, by limitingdemand for new supply, while privatization and full-cost recoveryprices reduce government responsibilities for maintenance of infra-structure.

It is important to understand that two distinctly different markets exist.The often most discussed and practiced is the informal markets or tem-porary transfers of the right to use water. This market has often beenpreferred, because it does not change the underlying allocation of theresource, since the water right remains the property of the seller. Thismarket allows irrigators to respond to temporal changes in market con-ditions, climate, farm problems, and personal circumstances. However,productions involving considerable long-term capital investmentsrequire formal water markets with permanent transfers of the waterrights, especially if such crops suffer long-term or permanent damageduring prolonged periods of insufficient supply. Permanent watermarkets often encounter more resistance because of the potential long-term community impact, but permanency is imperative if one of thepolicy objectives is to promote structural adjustment and/or to removethreats of environmental impacts from intensive irrigation of unsuitablesoils.

3. Country experiences with water marketsMexicoWater trading both permanent and temporary took effect in Mexico in1994 with a new water act. Water rights are based on consumptive use,water lost through seepage or return flows can therefore not be traded.

Environment and Development Economics 771

When water transfers do not change the intake or discharge of water noapproval is necessary the transfer simply has to be registered.Consequently, transfers within water user organizations can take placefreely and at low cost. Water transfers can also be made on a communalbasis. In Modulo 7 of the Delicias system, in the state of Chihuahua, thecommunity meeting decided to irrigate only part of the Modulo in 1999. Itwas agreed that the irrigators in the rest of the Modulo should sell theirwater to the selected area, which was the most productive and efficientlyirrigated, and the price was agreed on as well (Siqueiros, GerentAssociacion de Agriculture Modulo 7, pers com 1999). If the transfer is toanother district, the situation is vastly different. In that case, a majority ofthe water user organization must agree, the government must approve it,and the proceeds are paid to the organization not the individual. Thisseverely curtails transfers between districts (for a further discussion seeRosengrant and Binswanger, 1994).

India and PakistanInformal water markets have existed within irrigation districts in countriessuch as Pakistan (Meinzen-Dick, 1998) and India (Shah, 1993) for manyyears, often against the law. Markets are rather localized and facilitate aflow of water from larger selling farmers to smaller buying farmers. Wateris extracted by tubewells with either diesel or electric pumps. Smallerfarmers cannot afford such installations while larger landholders can.Many of these install pumps with excess capacity and therefore can sellwater. Various arrangements for payment are in operation. Payment caneither be in the form of cash or labour, it can be both two- and three-wayshare farming. Two-way share farming, where one party supplies thewater and the other the land, and then all other costs and the profit areshared. Three-way share farming is where one party supplies the water,one the land, and a third the labour and then all other costs are shared.Share farming arrangements ease one of the problems associated with thismarket system, that in case of shortage or crucial timing the sellers tend tolook after their own interests first. Under any of the share farming arrange-ments the water sellers will have a direct interest in securing a timelysupply of water to the buyer.

These informal markets have increased both the availability of waterand the reliability of supply and facilitated a more socially equitableoutcome of irrigated farming within the community. However social con-cerns are also raised: groundwater in both countries is an open accessresource and electricity cost often heavily subsidized, hence the ability tosell water encourages sellers to keep pumping to maximize the profit fromthe investment in infrastructure. This results in declining groundwatertables and thereby increased pumping costs for all pumpers. In someinstances smaller landholders with more shallow wells and smaller pumpsmight be unable to continue pumping. Further, in smaller villages withonly one large seller and many small buyers monopolistic outcome is theresult with high prices and social hardship for the small buying farmers.Markets work most effectively in areas where a large number of pumpsexist. If one seller supplying one particular area increases prices, other


sellers will extend their pipe system or canal system to supply that area aswell, thus eliminating monopolistic behaviour.

The southwestern USIn the southwestern US, water rights are defined by prior appropriation,which follows the concept of first in time, first in right. The person first reg-istering the beneficial use of a certain volume of water, at a given point ofthe river, will have a senior right to that water. Water users registering sub-sequent rights, will be junior and can only use the water, when the seniorright has received entitlement. The judicial system has developed overmany years, to settle disputes related to water transfers between indi-vidual diverters, resulting in a change of the point of diversion. Changesto the point of diversion have impact on return flows and thereby changeswater availability for downstream right holders. Some US jurisdictions,such as Colorado, New Mexico, and California, have attempted to solvethis problem, by only allowing transfers of the volume of water which hastraditionally been consumed, leaving the return flow in the river (Gould,1989). However, the judicial system has caused significant transfer costsand lengthy processes in determining what consumptive uses are andvaries greatly across jurisdictions (MacDonnell, 1990). In New Mexico andUtah, where the office of the State Engineer determines whether or not thetransfer will adversely affect other water users, transfer times and costs arelower. While buyers and sellers can appeal the decision of the Engineer’sOffices, they are accepted and not challenged 99 per cent of the time(Howe, 1998). Archibald and Renwick (1998) found that the presence ofadministrative and policy induced transfer costs significantly reduced thepotential efficiency gains from trade, and concluded that such gains couldnot be realized without institutional changes. As a consequence, watermarkets have largely been limited to inter-organizational transfers whereno change in point of diversion takes place (Thompson, 1997).

Most water trade in the US involves transferring water from agricultureto urban uses, or to industrial, uses such as mining and power generation.This involves significant volumes of water, and therefore causes seriousconcern about the long-term impact on community cohesion and culture(Dumars and Minnis, 1989; Mumme and Ingram, 1985). In some areasmarkets experienced significant fluctuation in activity and prices duringperiods where major companies required water to start up new projects(Colby and Bush, 1987).

Many water sources in the US are organized within mutual or ditchcompanies providing water through a network of canals. Irrigators ownshares in the company entitling them to a certain volume of water. Theseshares are freely transferable within the area, and with them the water.Trade therefore takes place frequently without controversy and within anadministrative environment at low cost. An example used quite often isthe Colorado Big Thompson Project (Person and Michelsen, 1994). Anotherwater delivery system, within which trade can move water freely, is theBureau of Reclamation projects. Internal water markets have been activewithin some of these organizations, such as the Northern ColoradoConservancy District (Wahl, 1989) and the Central Valley Project in


California (Rosengrant, 1995). The opposition to external transfers havebeen persistent (Thompson, 1997) despite the significant benefits for somemembers of the community from such trade (Wahl, 1989).

Water Banks have developed within a number of western states(MacDonnell et al., 1994). The longest serving bank is in Idaho, while thebest know is California’s Emergency Drought Water Bank (Carter, Vaux,and Scheuring, 1994). The California Bank sets both the purchase and thesales price based on farm budgets with some profit incentives for sellers(Howe, 1997). The Idaho Bank sets prices to approximate the sellers’financial obligations with no profit (Thompson, 1997). Both banks priori-tize buyers and the California Bank also determines what water can bedeposited in the bank. They therefore do not represent a normal market,where willing buyers and sellers exchange goods at agreed prices. Theydo, however, facilitate sales of large volumes of water, in periods ofextreme shortage, by providing smooth and fast transfers.

The US experiences indicate that water markets work most efficiently,and produce most consistent prices, the larger the trading area, the morediverse the water user group and the more developed the network ofmarket facilitators (Gardner, 1985; Brown et al., 1982). They also show, thatwithin areas where property rights are clearly defined and linked to sharesin the water delivery authorities, markets develop easier. Outside suchsystems, the legacy of past water paradigms has proven very hard to over-come, despite several state governments attempt to protect water sellersagainst claims of non-beneficial use (Thompson, 1997).

ChileChile has encountered drastic changes to its economic system since the1960s. Prior to then, water trade had been possible since the Spanish colo-nization, though not within what we would consider a free-marketenvironment. The period leading up to the Allende government in 1970saw increased state intervention. A comprehensive agrarian reform in 1967redistributed both land and water to the peasants and abolished trade inorder to improve social equity. The 1973 military coup changed this trendradically and introduced free-market systems following a neoliberal econ-omic ideology. Formal secure property rights in water were introduced in1976, markets in these were re-introduced in 1979, and included in the newNational Water Code in 1981 (Bauer, 1998; Lobos, 1999).

The Code separated the water right from the land, made them freelytradable, enabled them to be registered in the Real Estate Title Offices, andmade it mandatory to register all water transfers there. The Code distin-guishes between consumptive and non-consumptive rights. Non-consumptive rights are mainly for power generation, and the holder ofsuch rights must return the water to the river in a way that does notdamage the rights of other users. This issue has created conflicts betweenirrigators and power generating companies (Brehm and Quiroz, 1995;Bauer, 1998). Consumptive water rights allow for full consumption of thewater, which means that downstream users have no right to return flow. Ifwater use patterns upriver are changed, due to water transfers orimproved water use efficiency, the return flow to the river is reduced, with


detrimental impact on downstream users, against which they have nocause of action. The Code also provides other classes of water rights, suchas contingent rights giving the right to extract water during specifiedperiods of excess flow. Water rights can also be defined as continuous ordiscontinuous rights, where the continuous rights can be used 24 hours aday, while discontinuous rights can only be used during certain periods.Finally rights can be defined as alternate rights, where the water has to beused alternately by different users (Brehm and Quiroz, 1995).

If the transfer changes the point of diversion, government approval isrequired, and affected parties can protest if stream flows are changed.Since the disputes have to be settled in the courts, it appears that theperson who can afford the best lawyer wins. These are normally thebuyers, represented by urban water suppliers or larger farmers (Gonzales,Gerent Junta de Vigilancia del Rio Grande y Limai, pers com 1999).According to Sr. Peralta (Presidente Confederacion de Canalistas de Chile,pers com 1999) this is due to lack of expertise by the authority estimatingthe potential changes to stream flows and not a problem with the WaterCode. The Director General De Aquas believes that changes are requiredto give the Director greater influence on granting water rights, approvingwater transfers, and settling water disputes. However, such changes havealways been defeated in Parliament (Peña, Director General de Aquas, perscom 1999) due to the significant political influence of major private busi-ness interests and neoclassical economists.

It is interesting to note that during the process of developing the WaterCode, water users showed little interest in water trade per se, but greatinterest in providing security of water rights. They did not expect thatmuch trade would take place, but that greater security would encouragewater users to invest in more efficient water infrastructure (Bauer, 1998).This point was highlighted, when the national water users’ organization in1985 negotiated a new Act, giving assistance to new irrigation infrastruc-ture by up to 75 per cent of the cost, once the water user(s) have completedand paid for the project (Peralta, pers com 1999).

The success of the new Water Code has been widely acclaimed byHearne and Easter (1995), Rosengrant and Binswanger (1994), Schleyer(1994), and Brehm and Quiroz (1995), while Bauer (1998) has taken a morecritical stand. In reality the volume and frequency of permanent transfershave been low, mainly involved urban or industrial users, and activatedunused water (Peña, 1996). Hearne and Easter reported 47 transfers duringa seven year period in the Elqui Valley, while Bauer recorded 13 transfersper year in Los Angeles and 23 in Los Andes, which is a higher value pro-ducing area. The exception is the Limari Valley, where market activitiesare high, due to the flexibility of gated canals with flow meters, and thedefinition of water rights as volumes of water stored in three intercon-nected reservoirs (Peña, 1996, Hearne and Easter, 1998). Temporarytransfers are more common and mainly take place between farmers on thesame canal (Brehm and Quiroz, 1995).

Bauer (1998) therefore raised the question. ‘Why have there not been any more transfers?’. The following impediments to trade have been ident-ified based on Bauer (1998), Peña (1996), Brehm and Quiroz (1995), and


discussions with Peralta, Gonzales and Peña as well as personal obser-vations during a visit to Chile in July 1999:

• The rigid system of water distribution. Water rights in Chile are defined byflow, controlled and divided according to water rights by fixed gates ateach property. If a buyer and a seller on the same canal transfer water,only the seller’s and the buyer’s gates have to be altered. If the watermoves from one canal to another, all gates in both canals have to bealtered making it very costly.

• Legal uncertainty. Only a relatively small proportion (35–50 per cent) ofrights have been registered in the Real Estate Title Offices. The DirectorGeneral De Aquas has his own register, also covering only a fraction ofall rights. The most secure registers are the canal associations, but theseare not coordinated. Further, water rights have been based on factsmore than formal law, that is, if you can prove you have used water formany years, you must have a water right.

• Social values. Many small water users are traditional farmers, for whomirrigation is a way of life and part of a culture, and, therefore, they couldnever sell water despite economic reasoning. This corresponds withfindings within Hispanic and Indian communities in the US (Mummeand Ingram, 1985; Ingram, Schneider, and Nunn, 1989).

• Availability of cheaper options. Irrigators can increase their irrigationefficiency, and under the new Water Code receive governmentsubsidy for such work. On the El Palqui Channel, irrigators are liningpart of their 44 km long supply channel with plastic. Water losses dueto seepage are estimated at 42 per cent (Aquirre, President of the ElPalqui Channel Water Users Association, pers com 1999). Similarly,many farmers have recently converted to drip irrigation, or are in theprocess of doing so. Irrigators can also get ground water or contin-gent water rights, which can be used to fill dams or rechargeaquifers.

Bauer (1998) provides a discussion of the contradiction between the newNational Water Code, modeled on neoliberal economics developed in theUS, with a strong judiciary and a system of precedent. In Chile, thejudiciary is formalistic, interprets the law strictly and literally and is notused to play a pro-active role, and the lack of precedent and adequatehydraulic knowledge have caused court findings to be unpredictable andcontradictory.

4. Southeastern AustraliaSoutheastern Australia constitutes the southern part of the Murray-Darling Basin (MDB), which includes Australia’s largest water resource,and covers parts of four states New South Wales (NSW), Victoria (VIC),South Australia (SA), and Queensland (figure 1). The Murray-DarlingBasin Commission (MDBC), which consists of the relevant Ministers fromthe States, the Capital Territory, and the Federal Government, manages theBasin under the MDB Agreement. This Agreement has existed since 1915.Initially it was only concerned with how the water resources of the Basinwere shared. Since the 1970s, the MDBC has steadily increased its sphere


of influence to the wider management of natural resources and environ-mental issues.

It has long been evident that the Basin’s water resources are over usedand that use still increases with potentially detrimental environmentalimpact. The MDBC therefore initiated an audit of water use. As a result, aCap on water use was implemented in 1997, effectively limiting water useto the 1993/94 level of development. How to achieve this was left to theStates, which all have the legislative power over water resources. Due tothe different development of water resources and water rights the impactof the Cap varies across the Basin. Further, the issues of allocations for theenvironment and in-stream flows are still being investigated, and the finaloutcome is likely to further restrict water availability for consumption.These issues have had a significant influence on the use and impact oftrade across the Basin. To overcome these cross-jurisdictional differences,state and federal governments as well as basin managers are driving thedevelopment of a National Water Trading Framework, and an InterstateWater Trading Pilot Project has been in operation within a section of theMDB (see figure 1) since 1998.

South Australia (The River Murray)The predominant water uses along the River Murray in SA are viticultureand horticulture especially in the Riverland which are located upstream ofMorgan (figure 1). These industries are characterized by high levels ofcapital investment, long lead time before financial break-even, and highsensitivity to variability of water supply, with significant long-term lossescaused by water shortage. The aim of the State government has thereforebeen to develop a water right with a 100 per cent security of annual supply.The government therefore moved early to prevent over allocation. In 1969


Figure 1. The Murray–Darling BasinSource: Map prepared by the Graphics Group, CSIRO Land and Water,Adelaide, December 2000.

a moratorium was placed on new licenses, and in 1969 and 1976 privatediversion licenses were adjusted according to past actual use plus com-mitted use. A similar adjustment was not made to water rights withinirrigation areas. Water rights within these areas were determined by prop-erty size and crop water consumption figures, based on inadequateknowledge of actual plant water use and on inefficient irrigation methods.This has resulted in excessive water rights within many irrigation areas,and since these areas are land constrained, irrigators within them cannotuse this excess water to expand.

All resources were allocated by 1976 and existing water rights reducedto reflect actual or committed use. This created community pressure tointroduce instruments which could provide water to new enterprises,mainly horticulture. South Australia was therefore the first state toofficially introduce temporary and permanent trade between privatediverters in 1983. Trade was not introduced within irrigation areas,because of the fear of the impact on individual systems if large volumes ofwater were traded out of an area. Trade within irrigation areas was intro-duced in 1989. With the new Irrigation Act in 1994, trade was opened upbetween irrigation areas and with private diverters. To allow the auth-orities, and irrigators within irrigation areas, to adjust to changes, thevolume of water exported out of any area has always been capped at 2 percent of total entitlement.

Water transfers are subject to the buying property producing anIrrigation Drainage and Management Plan. This plan has to show that theirrigation activities on the property have zero impact on the quality of riverwater. The implementation of these plans has however never been policed.Consequently the plans have not had the desirable impact, even though itseems to have increased over time (Bjornlund, 1999). Due to the conserva-tive allocation policies, and the early voluntary intervention to rein inexcess water rights, the MDB Cap was set at the 1993/94 level of allocationand not the level of development. As a result, trade can activate unusedwater without having a negative impact on water right holders.

Victoria (Goulburn-Murray Irrigation District, GMID)The GMID is Australia’s largest irrigation district, located in the northernpart of Victoria along the Murray River upstream of Nyah (figure 1). It con-sists of two supply systems, the Murray and the Goulburn. Thepredominant water use is dairy farming with sections of cropping andgrazing. The dairy industry, which is the high value user, has a highdependency on security of supply but also an ability to benefit from extrawater. The other water users are mainly cropping and grazing, having theability to adjust water use to fluctuating supply. The allocation policy istherefore two folds. First, water rights with a supply reliability of 97 yearsout of 100, and, second, sales-water allocations, which are announcedannually as a percentage of water rights depending on availability and aregenerally higher within the Murray system. No sales-water is announceduntil the following season’s water rights are secured in the reservoirs,thereby ensuring the high reliability level of water rights.

Throughout the GMID, the water table is very high, but its impact varies


significantly. In the east, the groundwater is fresh and can therefore bemanaged. In the west, it is highly saline causing areas with high soilsalinity levels resulting in reduced productivity, abandoned land, andsevere environmental impacts. The dairy industry is concentrated in theeastern part, with a pocket around Cohuna in the Murray supplied part ofthe west, while the low value water uses are in the west. These differencessignificantly influence the outcome of water trade.

Victoria’s response to the MDB Cap was to maintain the security level ofwater rights, while keeping total water use at the 1993/94 level of devel-opment, by reducing annual sales-water. Consequently, as trade activatesunused water, annual sales-water declines. Since the Cap, sales-water allo-cations have been very low or zero, this has caused problems within thedairy industry. Due to past experiences, with sales-water allocations inexcess of 100 per cent, dairy farmers have based their permanent pastureson an average of 160 per cent of water right.

The first experiments with temporary water trade were introduced in1987. Permanent and temporary trade was formally introduced with theWater Act, 1989. Regulations regarding permanent transfers were not inplace until 1991, and the first transfers registered in January 1992. Tradewas not permitted between private diverters and irrigation areas until1994. To control environmental impacts restrictions were placed on trade.The underlying principle is that trade can only take place if the water canphysically be transferred between the selling and buying property. Tradecan therefore not take place from the Murray to the Gouldburn system,only in the opposite direction. Further, trade is not allowed into proper-ties with highly saline soils. To avoid increased accession to the watertable, guidelines are in place, setting maximum water use levelsdepending on irrigation and drainage infrastructure. To be allowedmaximum water use, the property need to be laser graded, have adequatesurface drains, and have either a re-use system or access to off-farmdrainage.

5. Early experiences with water marketsEven though markets are quite active, relatively small proportions of thetotal volume of water allocated for irrigation are traded permanently.Within the GMID, permanent transfers moved on average 0.35 per centper annum of total allocation. Along the River Murray in SA, trademoved 1.7 per cent per annum. The analyses in this section are based onextensive interviewing by mail of buyers and sellers of permanent waterrights, and buyers of irrigated farm land, during the 1987–1994 period inSA and the 1991–1994 period within the GMID, and telephone interviewsduring the 1994–1996 period in both areas. A total of 921 interviews werecompleted.

Market activity and market pricesFigures 2 and 3 show the number of transfers, minimum and maximumprices on a quarterly basis, and volume of water traded on an annual basis,during the 1987–1996 period in SA and 1992–1996 period within theGMID. Along the River Murray in SA, trade was steadily increasing both


in volume and price. Price increases have continued, and are now consist-ently above A$1,000/ML. Price dispersion in percentage terms hasdecreased. Within the GMID, both prices and volumes of water tradedhave been steadier during the first five years, and price dispersion morepronounced. This could be a sign of a more immature market, but alsoreflects spatial restrictions and the differences between private divertersand irrigation area irrigators. Volumes of water traded have sinceincreased considerably to almost 25,000 ML during the 1997/98 seasoninvolving 350 transfers.

Within both areas, the removal of restrictions on trade between privatediverters and irrigation areas in 1994/95 significantly changed the patternof water trade. Along the River Murray in SA, irrigation areas onlyaccounted for 4.8 per cent of water traded from 1987 to 1994. Thisincreased to 35 per cent from 1994 to 1996. However, trade within orbetween irrigation areas still accounted for only 5.3 per cent. Within theGMID, private diverters accounted for 10 per cent of water traded from1992 to 1994. This share increased to 24.3 per cent from 1994 to 1996, with


Figure 2. Minimum/maximum prices and number of transfersThe Murray River—South Australia: 1987–1996

Figure 3. Minimum/maximum prices and number of transfersGMID—Victoria: 1992–1996

trade between private diverters accounting for 13.4 per cent. Within bothstates, the policy change increased market activities in the sector with thelowest activity level and moved water into the sector with the highestactivity level, only the direction of the move was opposite.

Bjornlund (2002) applied hedonic price functions to sellers and buyersduring the two study periods, to establish which factors influence waterprices. The large price dispersion within GMID was caused by threefactors: 1 The restriction on trade between private diverters and irrigationareas. Prior to 1995, private diverters paid up to A$150/ML less. This dif-ference was reduced to around A$40/ML after the restriction wasremoved, and was only if both the buyer and seller were private diverters.If a private diverter sold to an irrigation area irrigator, there was no pricereduction. This suggests lack of information. Private diverters, selling toother private diverters, are obviously not aware of the change in policy, orthe fact that the price level within irrigation areas is higher. 2 Within theMurray system, where trade is spatially restricted and sales-water alloca-tions higher, water prices were A$85/ML lower. 3 From 1992 to 1994 waterbuyers in the western part of the Goulburn system, where water is appliedto lower valued commodities and salinity problems most severe, paidA$32/ML less than in the high value producing east. Since water could befreely traded to the east, prices should not be lower. This is only possibleif information flow is inadequate. This is supported by the fact that watersellers in the west only received A$16/ML less. Obviously, sellers aware ofthe price level in the east, and selling their water that way, get higherprices. This changed during the 1994/96 period, where the hedonic func-tion did not suggest prices to be lower in the west, possibly reflectingincreased information flow within a maturing market.

Along the River Murray in SA, there were no spatial restrictions ontrade, but there were spatial differences in production. The high value effi-cient users were mainly located upriver in the Riverland. Downriver, at themouth of the river, water was mainly used for low value crops and irriga-tion methods were less efficient. During 1987–93, it was found that themore efficient irrigators, using drip irrigation and micro sprinklers, paidmore for water, while irrigators using flood and furrow irrigation wereable to purchase water at lower prices. This suggests that in the immaturemarket, with little information flow, opportunistic inefficient buyers, whocould not afford full market prices, are capable of finding cheaper water.

During the second period, when irrigation area irrigators increased theirmarket share, the price difference between private diverters and irrigationareas became measurable. Private diverters paid A$47/ML more forwater, whereas irrigation area sellers only received A$17/ML less. This isbecause most irrigation area sellers sold to private diverters and receivedhigher prices, whereas those selling to other irrigation area irrigatorsreceived lower prices. This issue was further emphasized by the fact, thatsellers using water brokers received A$22/ML more benefiting from thebrokers market knowledge. It was also found, that sellers located at themouth of the river sold water for A$40/ML less. These examples indicatedan inefficient and immature market with a lack of information flow.

The importance of market facilitators as price stabilisers is clearly


illustrated under the MDBC’s Interstate Water Trading Pilot Project. Dueto significant distances between buyers and sellers as well as increasedadministrative complexity, 99 per cent of both sellers and buyers used abroker. As a result prices varied within a fairly narrow band during thefirst two years of trade (Young et al., 2000).

Reasons for buying and sellingThe buyers and sellers were asked to rate how important they found anumber of reasons for buying and selling. They were asked to rate themon a one to seven scale. Discussions with irrigators in the regions, indi-cated that many are purchasing water as part of a ‘whole of farm plan’to both consolidate existing production and increase production. Buyersand sellers were therefore asked to rate all the reasons for buying andselling. Table 1 shows the reasons for buying and Table 2 for selling. Inthe tables the percentage of buyers and sellers finding each reasonimportant is reported. For the purpose of the tables, all ratings from 3 to7 are considered to reflect some importance. The mean rating for eachreason is also reported in brackets. The reasons can broadly be groupedinto two categories: ‘expanding reasons’, where the purchase of waterresults in an expansion of production, and ‘non-expanding reasons’,where the purchase of water is mainly used to protect and maintainexisting production. However, buyers might rate an ‘expanding reason’important without actually increasing the area. If they rated the reasonin the lower range of the scale (3 or 4), they might consider expandingat a later stage. Similarly, sellers might not rate it important to reducetheir irrigated area, they might have sold because they needed themoney, but as a consequence they might have reduced their irrigatedarea. Acknowledging this, buyers and sellers during the 1994/96 period


Table 1. The importance of various reasons for buying—The GMID and the River Murray in SA

% of buyers finding the reasons important1

1987–94 1994–96Reason: GMID SA GMID SA

Expanding reasons:Increase area of existing crops 47 (3.4) 52 (3.8) 56 (3.7) 65 (4.6)Grow new crops 60 (3.6) 55 (4.0) 56 (3.8) 66 (4.7)Establish first irrigationEnterprise 15 (1.8) 32 (2.8) 16 (1.9) 22 (2.3)

Non-expanding reasons:Increase water application

on existing area 53 (3.7) 27 (2.4) 78 (5.0) 36 (2.9)Security against drought 70 (4.8) 30 (2.3) 76 (5.1) 31 (2.4)Speculate in water 23 (2.0) 5 (1.2) 38 (2.7) 13 (1.6)

Note: 1 These categories are based on the respondents rating of the importanceof each of the listed reasons on a 1–7 scale. In the above table 1–2 is notimportant, 3–7 is important. Figures in brackets refer to mean values of the1–7 ratings.

were asked, whether they actually reduced or increased their irrigatedarea.

Within the GMID, where irrigators have permanent pastures and othersignificant investments depending on dwindling sales-water allocations,much higher importance is placed on ‘non-expanding reasons’, such asincreasing water on existing crops and drought security. The importanceof these reasons increased over time, as the impact of the MDB Capincreased the pressure on sales-water allocations. The ‘expanding reasons’are also rated highly but constant. Cross tabulations and Chi-square testswere applied to the respondent’s ratings. These supported the initialexpectations, that irrigators purchase water both to secure their existingproduction and to expand their irrigated area, to make their propertiesmore viable as a part of the general structural adjustment toward largermore efficient farms (Bjornlund and McKay, 1999).

Along the River Murray in SA, where all plantings are supported bysecure water rights, the ‘expanding reasons’ were rated most importantand increased in importance, reflecting the boom in viticulture and somehorticulture. The ‘non-expanding’ reasons were rated least important andremained steady. Within both areas, speculation in water increased inimportance showing growing awareness of water as an asset. Speculationwas rated most important within the GMID. This reflects that the ability tocash in on capital gains is much higher within this pasture- and cropping-based area. Once permanent plantings have been established, based onsuch water, it cannot easily be detached again. Analysis of irrigated farm-land in the Riverland showed that water, land, and improvements cannotbe separated in the hedonic price function (Bjornlund, 2001). Looking athow many buyers actually increased their irrigated area, it was found thatwithin the GMID only 40 per cent did so buying 43 per cent of the water.Along the River Murray in SA 75 per cent increased their irrigated areabuying 90 per cent of the water emphasizing that trade in SA increases pro-duction more. This reflects the different allocation policies and thedifferent definition of the Cap.


Table 2. The importance of various reasons for selling

% of buyers finding the reasons important1

1987–94 1994–96Reason: GMID SA GMID SA

Non-reducing reasons:Did not need the water 59 (4.1) 45 (3.2) 69 (4.5) 59 (4.1)Needed the money 57 (3.9) 71 (4.6) 61 (3.7) 58 (4.1)

Reducing reasons:Reduce irrigated area 25 (2.3) 20 (1.9) 20 (1.9) 20 (2.1)Stop irrigating 24 (2.4) 19 (2.1) 21 (2.1) 18 (1.8)Retire 13 (1.7) 15 (1.8) 12 (1.6) 15 (1.9)

Note: 1 These categories are based on the respondents rating of the importanceof each of the listed reasons on a 1–7 scale. In the above table 1–2 is notimportant, 3–7 is important. Figures in brackets refer to mean values of the1–7 ratings.

The reasons for selling can also be grouped into two categories. The‘non-reducing reasons’, where the sale mainly activates unused water anddoes not cause a reduction in productivity, and ‘reducing reasons’, wherethe sale does result in a reduction in productivity. Within both study areas,the ‘non-reducing’ reasons were by far the most important and generallyincreasing in importance. Less than 25 per cent rated ‘reducing reasons’important, and the importance of these was declining. This suggests thatmost water traded is unused water. Looking at sellers actually reducingtheir irrigated area, it was found that along the River Murray in SA, 31 percent of the sellers reduced their area, selling 31 per cent of the water.Within the GMID, 27 per cent reduced their irrigated area, selling 41 percent of the water. These figures suggest, that around one-third of all watersellers reduced their irrigated area indicating a quite significant adjust-ment impact in both areas.

Analysing water rights, volumes sold, and volumes used prior to sale, aswell as the sellers’ intentions to reduce irrigation, indicate that a number ofsellers, within GMID, might have to reduce their irrigated area in thefuture. About 25 per cent sold water on which their existing productiondepends, without any intention of reducing their irrigation (Bjornlund andMcKay, 2000b). This indicates a group of struggling farmers, unwilling toaccept reality and make the inevitable adjustment, which might be to theirlong-term financial detriment. Irrigated farmland analyses show that prop-erties with insufficient water for existing production carry a price penalty,and that the value of actively used water, when attached to land, tends toexceed the price paid for water in the water market (Bjornlund, 2001).

Higher value usesAnalyses of the water use of buyers and sellers, as well as which crop theywere going to expand/establish or reduce, enable an evaluation of tradesability to promote higher value production. The answer in both studyareas is clear—trade does promote higher value production. Water pur-chased to expand production, as well as that purchased to secure existingproduction, was applied to higher value crops and was sold by lowervalue users. Without trade, water would have remained with the lowvalue users, who are unlikely to have the financial means to convert tohigher value production and would therefore have remained unused orbeen activated for low value use.

As discussed above, most water was unused prior to sale (58 per cent inGMID and 69 per cent in SA) but was sold by low value users. Within theGMID, cattle producers sold 45 per cent of the water, sheep producers 26per cent, and 9 per cent did not have any water use. Major reductions inwater use took place among cattle and cereal producers, and many withmixed grazing and cropping reduced their cropping component ratherthan their grazing activities. Along the River Murray in SA, cropping prop-erties sold 42 per cent of all water and sellers not having any irrigation sold4 per cent. Most actual reduction in irrigation took place within croppingand vegetable production (Bjornlund and McKay, 2000a).

Within the GMID, dairy farmers purchased 69 per cent of all water andcattle producers 18 per cent. Out of the 43 per cent used for expansion,


dairy farmers used 67 per cent. Along the River Murray in SA, vineyardspurchased 36 per cent of the water while other horticulture and vegetableproducers purchased most of the rest with 9.8 per cent being purchased bynew enterprises. Looking at the 90 per cent of the water used for expan-sion, 57 per cent was used to establish vineyards and 30 per cent forhorticulture with 8 per cent for vegetable production (Bjornlund andMcKay, 2000a).

More efficient water usesBuyers and sellers of water were asked about their water use efficiency atthe time of trade. The issues were different within the two study regions.Within the GMID, water is supplied in open channels and applied bygravity using flood irrigation. The issues here are whether the land haslaser grading, surface drains, and re-use system. Buyers and sellers wereasked whether they had these facilities, and whether the buyers haveinstalled them as part of the water purchase. Along the River Murray inSA, pressurized pipes supply almost all water, and water is applied usingirrigation systems, either overhead sprinklers, micro sprinkler, drip irriga-tion, or centre pivot. Buyers and sellers were therefore asked whichirrigation system they used before trade, and buyers were asked whichirrigation methods they were going to use on new plantings.

Within both study areas, there was evidence that water moved to moreefficient water users, especially when considering the improvements thatbuyers have done in connection with the purchase (Bjornlund and McKay,2000a). For example in SA, drip irrigation was used by only 3.3 per cent ofthe buyers, whereas 35.1 per cent of all water purchased will be applied onnew plantings using drip irrigation. Buyers also monitored and managedtheir water application better, with 56 per cent of the buyers using poten-tiometers to schedule irrigation, against less than 15 per cent of sellers.Within the GMID, almost twice as many buying properties were lasergrade and had re-use systems.

Social, community and environmental impactsIt has been the hope of policy makers, that water trade would facilitate asocially equitable redistribution of water. It was anticipated, that thebuyers would be able to fully compensate the sellers and that sellers could:

• sell the water and the land separately in situations where that wouldbring the highest return, and the seller wanted to leave the property;

• sell the water and return to dry land farming, supported by off-farmwork and/or return earned on the capital gained from selling the wateror retire on the property;

• sell part of the water, either unused water or reducing the irrigated area,and invest the money in improving the remaining irrigation, andthereby make them long-term viable.

Our analyses suggest that these expectations were not fulfilled. Within theGMID, only 20 per cent confirmed that they used the proceeds from thesale to improve irrigation, whereas 63 per cent put it toward generalrevenue and 26 per cent toward debt reduction (Bjornlund and McKay,


2000b). Along the River Murray in SA, 27 per cent said they used the pro-ceeds to improve their irrigation efficiency, of those who did not, 59 percent put the money toward general revenue and 22 per cent used it for debtreduction (Bjornlund, 1999). These findings reflect the fact that the mostcommon reason for selling was the need for the money. To sell a long-termasset, to pay running costs or cover short-term debt, does not improve thelong-term viability of the property and cannot be repeated.

Comparison of water market prices and water value when attached toland raises some further social impact issues. Within both study areas, it isindicated that sellers of unused water are being handsomely compensatedcompared with the value of unused water when attached to land. On theother hand, if water is actively used for production, the value of that landis reduced by a larger amount than the seller receives for the water in thewater market. These problems are aggravated in areas where significantcapital investments are made in long-term water dependent farm improve-ments, such as plantings and irrigation systems. When attached to land,the value of water depends on the use to which the water is put, since partof the value of water has been capitalized into the value of these waterdependent capital investments. To fully compensate sellers of water usedfor production, prices need to be high enough to pay for both the waterand the water dependent farm improvements left idle by selling the water.(Bjornlund, 2001).

It thus appears, as if a group of sellers are selling water, on which theirpresent production depends, for less money than it is worth when attachedto land. These farmers are eroding the capital value of their property, andmany of them are using the proceeds to cover annual expenses. Such devel-opments can only further consolidate these farmers in the rural povertytrap. On the positive side, there is 25 per cent actually using the proceedsto improve their irrigation efficiency and 15 per cent in order to retire.

Analysing changes to farm and water right sizes indicates that tradegenerates larger properties with more appropriate water rights. Aftertrade, farm sizes are still within what must be considered family opera-tions. Trade, however, seems to widen the gap between smaller andwater-poor farmers and larger water-rich farmers. The former groupdepends on off-farm work, especially during periods of drought, while thelatter depends on a non-family workforce. There is no evidence that tradecauses a decrease in the rural population or a loss of amenities in ruralcommunities. Rather, trade seems to facilitate a stable but changing ruralcommunity by consolidating productive land and water into larger units,separating excess farm improvements and unviable land to be purchasedby ‘life-style’ farmers helping to uncouple the economy of rural communi-ties from farming (Bjornlund and McKay, 1999).

It follows, from the findings discussed under water use efficiency, thatwater trade generates environmental benefits. If water is sold, out of inef-ficiently irrigated and drained properties on saline soils, into propertieswith more efficient drainage and irrigation management practices on suit-able soils, it will reduce the negative environmental impact.

Analysing the soil salinity levels on selling and buying properties, in thewestern part of the GMID, where salinity problems are worst, shows that


water is moving out of more saline soils and on to less saline soils(Bjornlund, 1999). This is a positive result, provided some managementprogram is put in place to rejuvenate the saline soils. On the negative side,analysis of water movements up and down the River Murray in SA indi-cates that river salinity levels have raised by 0.6 EC due to changes indilution flow (Bjornlund and McKay, 2000b).

What is the state of water trading in Southeastern Australia now?When looking at the temporary water market, it becomes apparent thatsome issues still need to be addressed for the permanent market toflourish. Within the GMID, there was almost 4,500 temporary transfersmoving nearly 250,000 ML of water during the 1997/98 season. Within theMurray Region of NSW, the 1998/99 season saw 250,000 ML purchased by1,766 buyers compared with only 2,000 ML permanently traded.

Within all three states, water exchanges now exist for temporary trademanaged by the water authorities. Such exchanges have had a majorimpact on market operations. Supply, demand, and prices are now pub-licly known. Transfers, using individual agreements, are still mostpredominant, but the exchanges facilitate a considerable proportion oftransfers, varying from 10 to 40 per cent. Analyses of the temporarymarkets for the 1998/99 season indicate that the exchanges mainly facili-tate trade between distant parties, and transfers of smaller volumes ofwater. Larger transfers, and transfers between known parties, still tend totake place on an individual basis. However, the Exchanges serve as pricesetters for such private deals, and also facilitate some trade between neigh-bors, avoiding conflicts over payment. As an outcome price fluctuationshave declined. During the 1998/99 season, within the Murray Region ofNSW, supply and demand changed during the season. Because of thepublic nature of the exchange, high standard deviations of prices onlylasted a short period (Bjornlund and McKay, 2001a).

The exchanges cannot be compared with the US Water Banks. Pricesreflect buyers’ offers to pay and sellers’ offers to accept. Two differentmethods are applied. Within the GMID, a weekly clearing price is set,based on all offers to buy and sell, which facilitates the largest volume oftrade, what Howe (1997) calls a ‘sealed-bid double auction’. As a result,some buyers pay less than they are willing to pay, and some sellers receivemore than they are willing to accept, but no sellers receive less and nobuyers pay more. Within the Murray Region in NSW, buyers publish theiroffer to pay, and sellers their offer to accept, on a notice board at the officeof the authority and on the web. Trade can then take place between corre-sponding offers. Some buyers might choose to change their offer to matchsellers or vise versa. Deals can be concluded by mail, fax, or on the Web.This is a continuing auction system. Howe (1997) calls this method ‘theBulletin Board Water Bank’.

The question arises: Why this difference in market activity? Discussionswith irrigators, their organizations and water authorities indicate anumber of reasons for the preference for temporary trade:

1. Many industries are moving toward a position where they do not ownall their assets. Many farmers are cash strapped and leasing capital


equipment is therefore an option and becoming increasingly used. Theshort-term lease of water suits this concept, satisfies the institutionsfinancing leases, and can be organized to coincide with contracts forsale of produce.

2. Under the present tax system, temporary trade has tax advantages.Lease payments are costs, to be offset against annual income, and leaseincome can be offset by annual cost. For permanent trade, the purchaseis an investment and cannot be depreciated. For the buyer, such salesmight be subject to capital gains tax.

3. When buying annual water, the buyer knows when he or she buys oneML, that is what will be delivered, there is no uncertainty. On the otherhand, if an irrigator purchases one ML of water right, the annual allo-cation varies every year. The long-term allocation is uncertain, since theimpact of the Cap, on annual allocations, is not yet fully known, and theissue of environmental rights is still under investigation.

4. Sellers expect water prices to continue to increase, and know that sellingwater permanently has a negative impact on the value of their property,if and when they will have to sell. It is therefore better to hold on to theasset, if they can.

6. Lessons for developing countriesEfficient market outcomes will only be achieved under certain conditionssuch as: an efficient flow of market information, for example price,demand, and supply; secure property rights; efficient market facilitators,and sufficient research effort. Probably the best example of such an effi-cient market is the share market. Water markets, however, lack most ofthese characteristics largely due to the nature of the resource and themarket place, hence it is prone to market failures. An institutional frame-work must therefore be developed, forming the foundation for efficientmarket outcomes by providing incentives and information, guiding behav-iour, and thereby influencing market outcomes. This section will outlinesome of the areas that need to be addressed by such an institutional frame-work, based on the experiences discussed in this paper.

Within southeastern Australia it was demonstrated, how the earlyperiods of trade saw low volumes of water traded at widely fluctuatingprices. As markets matured, with increased market activity and the emerg-ence of market facilitators, price dispersion was reduced. The introductionof Water Exchanges for temporary transfers played an important role incommunicating market information and thereby increased marketefficiency. This situation saw buyers and sellers adjust very quickly tochanges to demand and supply during the season. This was also reflectedunder the MDBC’s Interstate Water Trading Pilot Projects and is sup-ported by findings of Brown et al. (1982) in the US.

Lesson 1New countries intending to introduce water markets, must developmethods of communicating market information to irrigators at the outset,and design the practicalities of market operations. The methods should beadapted to local circumstances, and preferably utilize channels of commu-


nications which already exist and with which irrigators are familiar andconfident. Especially this could be important in many developing coun-tries, where the ability of well-informed and well-financed buyers tobenefit from ill-informed and poor sellers is much greater than in a countrylike Australia. Experiences from Chile support this. It was found that low-income farmers did not benefit from the new Water Code and water trade,rather they were at risk of losing out.

The research by Gardner (1985) pointed out the importance of freeing upmarket restrictions, allowing a wider group of buyers and sellers to trade,representing both low and high value users, and users with differentsecurity of supply. This was clearly demonstrated in Australia, whererestrictions on trade between different classes of irrigators were removed,resulting in more uniform, higher prices, and the activation of unusedwater. This is also supported by experiences in Chile, where the mostactive trading developed in an area where water could be freely trans-ferred over a large region, due to the interconnection of three major dams.

Lesson 2Effort should be made to remove obstacles to the spatially free movementof water, as well as the movement between different classes of waterrights. This might be an area where government intervention can be bene-ficial, by financing the necessary infrastructure to facilitate or free up thespatial movements, since such investments are not within the reach ofmost individual water users.

In Australia, the issues of total resource use, unused entitlements, andenvironmental and in-stream needs were not addressed prior to intro-ducing water trading. This has resulted in uncertainty about futureallocation levels and is generating conflicts within irrigation communities(Bjornlund and McKay, 2001b). This uncertainty also constitutes an imped-iment to the use of permanent water trade, in preference to temporarytrade which does not promote long-term investment in efficient andenvironmentally sustainable water uses.

Lesson 3The issues of total resource use, unused entitlements, and environmentaland in-stream needs should be addressed prior to the introduction oftrade. This process is politically sensitive, and the need for the devolutionof resource management is imperative here. Local communities need tounderstand the necessity of this process, and gainers and losers need to beidentified and accept the outcome, and compensation issues addressed.

In many countries, such as Germany, Spain, Mexico, Argentina, and mostof the west US, a version of the ‘beneficial use’ doctrine is used to deal withthe issue of unused water (Solanes, 1999). According to that doctrine,water has to be put to a beneficial use or the holder loses it. It has beenargued that this doctrine is an impediment to efficient water use since irri-gators will pour water on the field rather than loosing it. This is notnecessarily so; in Arizona it is combined with definitions of maximum


water use for all productions, and such norms are regularly revised inorder to reflect the development of technologies to use water moreefficiently (Johnson and Caster, 1999). In Chile, the lack of penalty on non-use has lead to the fear of speculation in water (Solanes, 1999).

Lesson 4It is important to consider the issue of unused water. Failure to addressthis issue with adequate regulatory mechanisms can lead to inefficient andunsustainable water uses and opens up for speculation and monopolisticbehaviour which can result in environmental damage, social hardship, andnegative economic impacts.

Australian experiences indicate that market outcomes vary significantlyfrom jurisdiction to jurisdiction, depending on the legacy of past waterpolicies and differences in major water uses. In Chile, the allocation policyis to issue more water rights than the available resource, factoring in tra-ditional return flows from upstream users as downstream supply. Aswater rights are defined as consumptive use, this return flow is not guar-anteed. As water trade, or increased water prices, encourage upstreamusers to introduce more efficient irrigation or conveyance methods, returnflows are reduced with detrimental impact on downstream users.

Lesson 5When developing water market policies and evaluating their potential ben-efits, it is important to thoroughly understand the legacy of past policies.

Free market environmentalists argue that as long as the government keepshands off, market forces will solve all problems (Anderson and Leal, 1991).This relies on the existence of strong interest groups, able and willing tolobby and pay for environmental and recreational benefits. In most devel-oping countries, such groups do not exist, or do not have the necessarypolitical and financial clout. In such instances, a balance must be struck, toreflect the society in which markets have to operate. On the other hand, weagree with Huffman (1994), when he says that there is no reason to abandonmarkets to protect the environment, but rather to introduce defensible regu-latory instruments, designed to minimize market distortions. In essencemarkets are excellent servants but poor masters (Young, 1997). They can beused to reallocate natural resources, providing a regulatory frameworkexists, to guide the process in the direction desired by the society.

Lesson 6The balance between private market forces and government regulation toprotectthird-partyinterest, includingenvironmentalconcerns,mustbefound.

It is essential that water rights are clearly specified and formally registered,so that the buyers have full information about the product that they arebuying, and ownership is secured. Such registers will also enable thirdparties to register an interest in the right, such as mortgages. In a recentpaper we suggested that the following issues must be addressed to maxi-mize the outcome of water markets:


• Security of supply specified as the probability of receiving the volumetric enti-tlement. If a government has the authority to cancel water rights, theconditions for such cancellations must be clearly specified. In areaswhere allocations are announced annually, as a per centage of waterrights, it is important that the process of determining the allocation istransparent. Announcements of allocations must be made early in theseason, and changes made regularly, as the factors affecting the allo-cation changes. Such factors should be public, and the changes to thesefactors communicated to water users.

• Reliability of delivery, specified as the period from ordering to receiving thewater.

• The period during which the water can be used. The lack of this definitioncaused problems in Chile between consumptive and non-consumptiveusers.

• The constraints on trade, such as spatial constraints, limitations on tradebetween sectors in the economy, only consumptive use, etc. must be clearlystated.

• Some indication of the expected quality of the water.• The duration of the water right, either indefinite or for a specified period of time.

In the latter case, the likelihood of the right being renewed, and thefactors determining the renewal, must be stated.

Lesson 7It is essential that water rights are clearly specified and formally registered,so that the buyers have full information about the product that they arebuying, and ownership is secured. In many developing countries, whererecords are parsimonious, the water use based on customary rights, it isimportant to assist water users in rectifying this prior to introduction oftrade or allow for a transition period (Velasco, 1999).

In many states in the US, disputes are handled by the judicial system, andcan be very time consuming and costly. Chile adopted the US approach,without a framework where the courts create precedents and with apassive judiciary. As a consequence, the outcomes of court procedures areunpredictable and contradictory. In Australia, disputes are settled withinan administrative framework. In Victoria, clear guidelines exist as to howmuch water can be used on a property, providing some certainty. In SA,buyers have to produce an Irrigation Drainage and Management Plan, pro-viding less certainty. Within SA and NSW, it has been suggested to requireall irrigated properties to have a water management plan, setting out howmuch water can be attached to the property, and the conditions underwhich it can be used. If such plans correspond with state-wide, as well aslocal water management plans, setting out environmental and socially sus-tainable limits for trade, the need for case-by-case evaluations would beeliminated, and thereby speed up transfers and reduce costs.

Lesson 8It is important that procedures and conditions for water trade are explicit,and designed to accommodate transfers quickly and at low cost. This


requires that conditions for trade are clearly specified, and that proceduresfor settling disputes are in place.

Societal acceptance is a prerequisite for a successful market (Simpson,1994; Brown, 1997). Both in the US and Chile, cultural issues have beenidentified as impediments to trade. In Australia community concern wasone of the initial barriers to the introduction of trade. One way of ensuringthis is to encourage and strengthen water user organizations. Experiencesin Chile have proven that such organizations can be instrumental in facili-tating markets.

Lesson 9It is important to identify cultural and religious values associated withwater use, and how these can be equitably incorporated into the market. Itis increasingly being accepted that pure neo-classical economic and marketbased approaches are falling short of social and non-economic aspirationsin many developing countries (Appelgreen and Klohn, 1999).

ConclusionsThere are many benefits to be gained from water markets in developingcountries, and many lessons to be learned from existing and emergingmarkets. However, markets need to be adapted to the local social fabricand environmental constraints and have to take into account the legacy ofpast policies. The above lessons clearly indicate that successful marketsrequire complex institutional and legal frameworks, as well as strongsocial and economic capacities. Many developing countries, especiallylow-income developing countries, lack these structures and capacities.Formal water markets are therefore unlikely to be successfully imple-mented, while their implementation in better-established developingcountries are likely to be postponed until resource conflicts are so severeas to force the hands of governments. There is a clear role to play here fordevelopment aid organizations to assist in setting up the institutional andlegal frameworks required. While this takes place, informal water markets,such as those discussed in India and Pakistan can play an important rolein facilitating a more equitable access to water resources.

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bjornlund (2002)

Documents

hereaspects of water

water policy

water managers

introduction of markets

mature markets

water market reforms

university of south

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