A Transactions Cost Approach to the Theoretical Foundations of Water Markets¹

Abstract

Water marketing is often cited as a means of alleviating the stresses attached to allocation of water use. Frequently, marketing is suggested in a context that implies substitution of competitive markets for the allocation based on the prior appropriation doctrine. This study examines water marketing from the perspective of a transactions cost approach to the private and broad social agreements (contracts) that support water allocation. It examines the major behavioral challenges faced by any contract, and the alternative approaches to those challenges, with respect to water allocation. It also examines the impact of market design on the existence of externalities, costs imposed by transactions on society and individuals not party to the transaction. It finds that the most robust water market designs will be found in systems with sufficient property rights protection to support investment, sufficient hydrologic information to provide accurate analysis of third party effects, conjunctive management of surface and groundwater, and a governance structure capable of administering the rules while not determining outcomes.

Mandates vs markets: addressing over-allocation of Pacific Northwest River Basins

“…It is not true that environmental values must necessarily he excluded. It is quite possible to devise means through which the environment may he valued in the market, and through which public values may he protected (Williamson, 1985;North, 1990;Slaughter, 2009).…”

“…Users obtain, through first use (constitutional method) or application to a State agency (statutory method), a right to divert water for a beneficial use on appurtenant land. While opinions differ, the general view is that the diversion right approaches the status of a property right, with restrictions (Slaughter, 2009). The Riparian Doctrine generally allocates water to land that directly abuts a water course, with constraints on change or diminishment of the resource.…”

Economic Principles for Water Conservation Tariffs and Incentives

“…Reduction in water waste through voluntary trading is often difficult to achieve. In many situations, water customs, water rights law and lack of physical infrastructure make trade impractical or impossible (Slaughter, 2009). Trade in water requires a form of ownership consistent with trading.…”

“…Third-party effects arise when such decision directly affect water availability to services and people that are not directly involved in a decision. Third-party effects are also denoted as externalities and spillovers and are relatively common in water management (Slaughter, 2009) Water withdrawals from a water body potentially affect other water users. Water withdrawn from a reservoir for municipal use and irrigation may have negative impacts on boating, fishing and valued ecosystems.…”

Exploring China’s Farmer-Level Water-Saving Mechanisms: Analysis of an Experiment Conducted in Taocheng District, Hebei Province

“…Attempts at adopting tradable water rights systems in China have been challenged by a number of practical issues related to market forces, technological conditions, risks and uncertainties and prohibitively high transaction costs [24,25]. Many studies have highlighted transaction costs as the major constraint for the success of water rights trading systems [26,27]. Water trading regime modeling studies that simulate the effects of transaction costs provide additional evidence that trans-jurisdictional water markets can lead to considerable potential benefits if transaction costs are not present; with transaction costs, water trading benefits increase as transaction costs decrease [23,28].…”