Markets, Water

Some people think of water as a gift of nature, with profound cultural, spiritual, and aesthetic significance, concluding that such a natural resource should not be bought and sold like fast-food hamburgers, t-shirts, or diamond rings. But water has many uses and immense total value, and if people want to use it to maximum benefit, they must have some mechanism to decide who gets it, when, for what purposes, and at what levels of quality.

At one extreme, a government might allocate water. Government officials would decide who gets how much, for what uses, at what times, and how to invest in the search for additional sources. At the other extreme, individuals who want to use water might be allowed to make these decisions, diverting water from streams or pumping it from wells, using it entirely as they wish and buying and selling it at will. Problems exist with both approaches, and probably no complex society has ever used either allocation procedure in its pure form.

Balancing Cost and Benefit

How much water should be used? In the figure below, each point on the marginal benefits (MB) curve indicates the amount consumers are willing to pay for the last unit of water purchased. Generally, the more one has, the less intensely one wants additional amounts. Hence, this curve slopes downward from left to right.

The marginal costs (MC) line shows the value of resources necessary to produce an additional unit of water. Generally, higher rates of flow can be had only at higher cost, so this line slopes upward.

Markets, Water

Consider the flow rate q 1 . Here, MB > MC, indicating that consumers value an additional unit of water more than the resources necessary to produce it. This calls for increasing the quantity produced and consumed. At q 2 , the opposite holds true. Only at q e does MB = MC. No incentive exists to either increase or decrease the amount produced; buyers and sellers have achieved the optimum quantity. This conclusion rests on the assumption that the MB and MC curves include all costs and benefits, whether they accrue to the buyer or the seller or to some third party.

Consider a problem sometimes created when a farmer sells irrigation water to a distant city. Much of the water applied to fields would have seeped through the ground and eventually back into the stream, thus becoming available for reuse by people living downstream. If the city diverts the water into a canal or aqueduct , however, the irrigation return flows are cut off, and the downstream users, who have not been a party to the transaction, are deprived of a resource without compensation. The private marginal benefit and cost calculations that led to the optimum q e may ignore "external" or third-party effects.

These effects have led many to conclude that governments must regulate water use tightly despite the high costs, delays, and controversy engendered by public decision processes. Economist Terry L. Anderson and others argue that properly defined water use rights would prevent much of the problem, in both quantity and quality dimensions—just as property rights in real estate, for example, prevent neighbors from encroaching or dumping trash into one another's yards. Indeed, the lack of well-defined water rights is the basis of much inefficiency and public controversy.

Market Institutions and Efficiency

Historically, the eastern United States generally enjoyed abundant water supplies, so the efficiency offered by market institutions was unnecessary (although this rosy picture darkened somewhat in the late twentieth century). Eastern states have mostly adopted variations of the riparian doctrine of water rights: owners of riparian land abutting streams have the right to withdraw water.

Market institutions have a longer history in the arid western states, where early settlers established efficient market systems on a type of firstcome, first-serve basis known as the prior appropriation doctrine. In New Mexico, Colorado, and Utah, for example, it is possible to buy and sell rights to the use of stream flows or groundwater and divert such purchases away from any riparian (streamside) land. Transactions crossing state lines pose further difficulties, even for these states, and have been handled by rather rigid interstate compacts .

Market institutions require a clear definition of what it means to own the right to use water as well as the right to sell or buy such rights. Even the most efficient market entails some transactions costs, of course, to cover fees of brokers, agents, lawyers, and so on. But market transfers generally involve fewer people and clearer rules and so minimize such costs. In sum, market institutions offer an underused path to increased efficiency in water use.

SEE ALSO Demand Management ; Law, Water ; Pricing, Water ; Prior Appropriation ; Rights, Public Water ; Rights, Riparian .

James E. T. Moncur


Anderson, Terry L. Water Rights: Scarce Resource Allocation, Bureaucracy, and the Environment. San Francisco, CA: Pacific Institute for Public Policy Research, 1983.

Howe, Charles W., Dennis R. Schurmeier, and W. Douglas Shaw Jr. "Innovative Approaches to Water Allocation: The Potential for Water Markets." Water Resources Research 22 (1986):439–445.

Roumasset, James, Rodney Smith, and James Moncur. "Optimal Allocation of Ground and Surface Water on Oahu: Water Wars in Paradise." In Conflict and Cooperation on Trans-Boundary Water Resources, eds. Richard E. Just and Sinaia Netanyahu. Boston, MA: Kluwer Academic Publishers, 1998.

Saliba, Bonnie Colby, and David B. Bush. Water Markets in Theory and Practice: Market Transfers, Water Values and Public Policy. Boulder, CO: Westview Press, 1987.


Relying mainly on water rights granted by the nineteenth-century monarchs, Hawaiian sugar planters developed extensive irrigation systems, according to their estimations of benefits and costs. They frequently bought or sold water rights, usually small amounts, as their needs changed, in transactions that were not much more involved or controversial than, say, buying a car. Titles were recorded officially by the government.

In 1972, however, the Supreme Court of Hawaii invalidated private water rights. Today, water transfers require elaborate and costly state approvals. No water sales have been recorded since 1972 despite vast changes in the state's water-using economy. Water allocation has been a continual major subject of public controversy, with costs for one single court case reaching millions of dollars.

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