Water restrictions in towns and cities around Australia make striking headlines. The latest proposal of Victoria's Bracks government is to spend $1 billion swapping Melbourne's waste water with fresh water used by industry in the east of the state.
This exploits the urban legend of natural shortages in drinking water, but only 15 per cent of Australian water is for domestic or industrial use. Even though Australian rainfall is irregular, there is plenty of scope to satisfy this demand.
Irrigation water is another matter. Having water at the right time and place means enhanced agricultural productivity. Hence, demand has grown for irrigation water and its associated water storage and diversion schemes.
By 2001, irrigated agriculture was using 16.6 gigalitres of water per annum and generating a gross value of $9.61 billion.
Yet over the past decade, the pace of this growth has been overshadowed by an increase in competing environmental claims. Together the two factors have created a scarcity of water.
But scarcity is nothing special in our society. The trading in markets of rights to all sorts of scarce resources is fundamental to social co-ordination.
However, a good deal of debate remains over the suitability of the market mechanism when applied to the allocation of scarce water resources between competing uses. This is despite the extent of the different values of water both over time and space. Such large differences imply that strong gains are available to society from trading water in markets.
To be truly effective, water trading requires private ownership and a regulatory relaxation over water resources. Yet government is seeking to maintain control, allowing it to hold on to the ability to achieve their individual goals through making allocations to vested interest groups.
Water is in many circumstances a fugitive resource -- it moves through the environment in ways that can be difficult to trace. In addition, some of the uses of water produce a public good -- namely those associated with environmental protection -- which by definition are non-excludable and therefore impossible, or at least extremely costly, to defend against use by those who do not pay.
In spite of these difficulties, there are powerful arguments in favour of using markets. Without them, the incentive structures facing politicians and their advisers create transaction costs of a different sort. Without a market in water in which alternative allocations are priced, there is little possibility of politicians and their advisers achieving efficient allocation for society.
In the absence of a water market, regulatory decisions have no measure to determine their true costs and hence a particularly fertile field emerges for bureaucratic empire-building with all the dead-weight costs that entails.
Even if politicians and their advisers could be relied upon to make decisions on water that are not dominated by personal motivation but are in the best interests of the wider community, it remains doubtful that they could allocate water efficiently.
This is because of the high -- often impossibly high -- costs faced by the state in collecting and processing in a timely fashion the sort of information required to ensure the most efficient uses of water at any particular time.
Among the pieces of information regulators would need to assemble to do the job routinely managed by markets is knowledge of the value of different extractive uses of water available from the production of irrigated crops and non-extractive environmental values such as the values arising from the protection of riverine ecosystems.
There are obvious complexities involved in estimating the latter, non-marketed values but even the task of estimating extractive values in real time is by no means straightforward given government difficulty in finding out the real values that private producers place on their use.
The current evolutionary trend in Australia is towards the use of markets. Numerous reforms are under way or proposed in that direction. However, "restraints to trade" in water rights remain, particularly between urban and rural uses and between extractive and environmental uses.
The process by which water is assigned for environmental flows remains arbitrary.
The Victorian government's latest water-swap proposals demonstrate that governments have an irrational aversion to building new dams and remain reluctant to subject investments in water infrastructure to a full cost-benefit scrutiny.
Removing uncertainties over property rights and the scope for regulatory intrusion is essential to enable greater environmental and economic wealth to be generated from our water resources.
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