Transaction Costs and Welfare in the Permanent Water Market in NSW

Abstract

Many economists and policy makers have begun to question the efficacy of water reforms that rely on markets as the principal mechanism for allocating the resource to its highest value use. One of the principal concerns in this regard has been the relative paucity of permanent trades despite ex ante analyses that have identified substantial and quantifiable gains. This phenomenon has been attributed to the transaction costs pertaining to deals in the permanent water market. Whilst some empirical evidence is now emerging on the quantum of these transaction costs, only limited attention has been given to the broader welfare implications of policies that might alter these costs. This paper examines the welfare implications of the transaction costs in the market for permanent water entitlements in NSW by employing a threshold valuation approach. Drawing upon empirical estimates of transaction costs by Crase et al. (2001), choice data are manipulated to provide estimates of foregone market surplus as the foundation for establishing threshold environmental values.