In its most basic definition, a water market is an arrangement in which holders of water rights trade them with each other or to outside parties. However, there are differences between water markets, and design will depend on the prevailing hydrological regime, including whether trades involve surface water, groundwater, or both; the previous existence of informal water rights and trading; the types and numbers of water users and right holders, including whether all are irrigation farmers or from different water-use sectors; and the physical arrangements for moving water between users. However, appropriate institutional arrangements must be in place to ensure positive outcomes from water markets.
The implementation of water markets requires both government involvement and active water-user participation. Institutional ingredients needed for other approaches to improving water-resources management-such as an administrative system that registers and enforces timely water deliveries, a transparent and accepted water measurement system, and a well-maintained delivery system-are all required for a functioning market. Therefore, the difference between the implementation of administrative systems and a market system may not be as large as expected. The principal difference is the need for the following:
- Definable and transferable water rights. Reallocation by trading means getting compensated. That is different from administrative reallocation, where right holders may not receive any compensation when water is reallocated to a different use. Under water markets, right holders will not only consider what the water can produce for themselves, but also the opportunity cost of the water (such as the value added by using the water in car manufacturing). Thus, the highest value of water use is taken into account, providing an incentive for more efficient use and reallocation of water to a higher-valued use.
- Internal institutional market arrangements. Buyers and sellers need to find each other and have confidence in the characteristics of the goods they want to exchange. In a well-functioning water market, this implies measuring the water available for trading, developing a simple mechanism to find prospective buyers and sellers, and carrying out the transfer. If the official transfer is difficult, then informal trading will likely occur anyway. The disadvantage of informal trading is that water use is hard to track. This is the case in Mexico and India, where groundwater levels keep sinking despite water trading.
- A physical delivery system. Traded water is likely to move from one user to another. Depending on the hydrological conditions or previously constructed infrastructure, the cost of adequate infrastructure may be too high and outweigh the benefits from transfers, rendering the water price so high that no buyers can be found. The government may absorb the cost, but thorough analyses are needed to establish whether the introduction of a tradable system will produce sufficient societal benefits to warrant large investments.
Imagine a river where a right holder uses only 70 percent of her water so that the remaining 30 percent is available for her neighbors. If she decides to sell her full right to a buyer who will use all of this water, then the downstream neighbors will be deprived of the extra water, which they count on. They may go to court to prevent the sale, thereby causing high transaction costs, or courts may not be available and they will have to accept the loss. A mechanism is therefore needed to either negate third-party interests or to mitigate the impacts of water trading on the different stakeholders, including an effective conflict resolution system. Such a system could be linked to water courts or taken care of by the riverbasin management agencies where the market is located.
The most challenging institutional feature of a water market may thus be the definition and registration of water rights, together with the implementation of adequate information and transaction mechanisms that provide equal possibilities for all water users to participate in the market. These mechanisms would have to include access to price information and the registration, enforcement, and monitoring of rights.
Developing countries characteristically suffer from weak institutional frameworks, such as slow judicial systems, unclearly defined land rights, strong concentration of land ownership, and unenforced laws and environmental regulations. Before the introduction of water markets, the necessary legal and institutional requirements in each site should be compared with what already exists. An evaluation should be made to determine whether the laws and institutions could be changed with low political and social transaction costs to permit the introduction of a well-functioning water market.
Socioeconomic asymmetries need to be considered because of the different types of water users, who will vary in their educational background, culture, and economic power. When water rights were allocated and made tradable in Chile, electricity companies bought up a large number of them to be held for future use, to the detriment of smaller users who at the outset did not understand the implications of their selling the rights. Given that water is the basis for agricultural production, the sale of a water right may severely undermine smallholders' livelihoods. In response, the Chilean government has been discussing the prohibition of holding water rights for more than five years without beneficial use.
As in the case of land rights, poor farmers may use newly allocated water rights to pay off their debts, ending up without their entitlement in the long run. A phased approach to water trading may be the most appropriate, starting with the introduction of water rights, monitoring, and enforcement, and followed at a later stage by tradability. This would give water users-especially the more vulnerable segments of society- the time to realize the value of their new rights. Instituting a seasonal or annual leasing system could also permit right holders to experience market transactions without permanently endangering their livelihoods.
Another important issue is the impact of water reallocation on higher-valued uses and their impact on regional economies and the environment. International experience is inconclusive. In Mexico, small farmers with severe groundwater overdraft do not have the capital to invest in deeper wells, so they sell their water rights to large agribusinesses that do invest in wells. The small farmers win because, without the water market, they could neither invest and nor receive any compensation. Furthermore, the company creates local and regional jobs. On the other hand, by obtaining more water rights, the company also strongly contributes to the declining groundwater level, thus hurting more small farmers and the environment.
The need for integrating a functioning system of waterresources management with the water market approach is clear. Such a system would include water measurement, enforcement, sanctioning of infractions, and user participation in decisionmaking about regional water-resources management goals. The Chilean and Mexican examples also show that water markets-like other approaches-have social and environmental implications that cannot be disregarded if they are to enhance sustainable development and economic growth.
Water markets can help improve water allocation and use. To function, they need a set of institutional arrangements, which are partly the same as so-called "administrative watermanagement tools," namely riverbasin management, water measurement, enforcement, sanctioning, water availability information, and water-user participation. In addition, some parts of the institutional arrangements needed are incremental, such as tradable water use rights, and appropriate infrastructure and transaction mechanisms.
A gradual approach to introducing water markets may be the most appropriate, putting into place water measurement systems, defined (though not tradable) water rights , and water user participation. In many settings worldwide, these steps would be the basis for much-improved water-resources management and would permit the stakeholders to get adjusted to a new set of rules. Eventually, rights to water use could be made tradable, but should take into account and make appropriate provisions for vulnerable user groups and uses, including the environment.
While the benefits of water markets can be substantial, potential negative socioeconomic or environmental impacts need to be included in the analysis prior to taking any steps toward implementation. The gradual approach proposed here would not only permit a long-term evaluation of institutional change, but would also help include the different stakeholder groups in shaping the institutional arrangements for water resources management.
For further information see Graff, J. T. and D. Yards, "Reforming Western Water Policy: Markets & Regulation." Natural Resources & Environmental Law, Vol. 165 (1998).; Hearne, R. R. and K.W. Easter, Water Allocation and Water Markets: An Analysis of Gains-From-Trade in Chile. World Bank Technical Paper No. 315. Washington, D.C.: World Bank, 1995.; Mariño, M. and K. Kemper, eds. Institutional Frameworks in Successful Water Markets: Brazil, Spain and Colorado, U.S.A.. World Bank Technical Paper No. 427. Washington, D.C.: World Bank, 1999.
Karin E. Kemper (kkemper@worldbank.org) is a senior water resources specialist at the World Bank.