Principles for Economically Efficient and Environmentally Sustainable Water Markets: The Australian Experience

Abstract

With growing water demand for cities and irrigation, periods of low inflow increasingly lead to “operative” droughts when supply is insufficient to meet all consumptive and environmental water demands. This chapter focuses on water markets as a mechanism for sharing scarce water in drought. The institutional arrangements in the Australian Murray Darling Basin (MDB) that have allowed emergence of what is arguably the world’s most active water market are outlined. The evidence, consistent with economic theory, confirming significant economic benefits from water trade during the recent Murray Darling Basin drought is presented. The yet unresolved challenges arising from increased efficiency of water use in response to water market incentives eroding environmental flow are discussed. The conclusions outline institutional design principles from Australian experience for realizing efficiency benefits and avoiding adverse environmental impacts when introducing water trade.