Water markets and trading

Abstract

Since the 1970s, supply augmentation strategies to meet water needs have waned, and governments have increasingly focused on demand management measures, including voluntary water transfers. Water demands have also changed as expanding urban growth, changes in agriculture, and increasing concern for the environment compete for water. Water rights regimes based on queuing principles lead to an inefficient allocation of water resources and may also result in other inefficiencies, such as overuse of land and inadequate adoption of capital-intensive conservation technologies. Water trading based on transferable water rights has been advanced as a solution to these problems. Trading helps equalize the marginal prices faced by various water users, thereby providing information about the value of water in alternative uses and creating compatible incentives. Putting water markets into practice introduces real-world complications of transaction costs and third-party externalities. We present these complications along with some major criticisms of water markets, and actual cases of water trading are discussed. We conclude with avenues of potential future research. Copyright © 2006 by Annual Reviews. All rights reserved.