From the May/June 2007 Issue
It may be everywhere, but it’s scarce as well. How to use water most efficiently? Roger Bate finds the solution in a nation undergoing the worst drought in 1,000 years: Australia.
“Water, water everywhere,
--Samuel Taylor Coleridge (1772-1834), “The Rime of the Ancient Mariner”
Australia has entered the fifth year of what one government official calls a “one-in-a-thousand-year drought.” The Murray-Darling river system, which provides three-fourths of the water consumed nationally, is more than 50 percent below its record minimum. The drought offers a vision of the future for many arid parts of the world, including the American West. But as bad as it is, Australia’s drought would be far worse if the country had not, two decades ago, initiated what is the world’s best system for trading water rights. As a result, water is flowing to its most productive uses, and there is more of it for drinking.
As Coleridge understood, the paradox is that, while there’s a lot of water in the world, it’s mostly either the wrong type or in the wrong place. Only 3 percent is fresh and much of that is locked in icebergs, glaciers, and inaccessible aquifers. Some countries have much more of the world’s supply than others. Canada has over 137,335 cubic yards of water per person, while Tunisia has only 654. But there is still plenty to go around if—and it’s a big if—it is used efficiently.
Water is recognized practically everywhere as a human right. Certainly, everyone should have enough for drinking, bathing, and other essentials. But by using a language of rights, governments often ignore the reality that water is scarce and that the best way to distribute any scarce resource is through trading. Instead, one economic sector in particular has been showered with water at a very low price, subsidized by the rest of the population. That sector is agriculture.
One economic sector in particular has been showered with water at a very low price, subsidized by the rest of the population: agriculture.
Even industrialized countries allocate about half of their water to farming. In Japan, for instance, agriculture represents around 1.5 percent of GDP but consumes more than 60 percent of fresh water. In developing countries, a considerable majority of fresh water is used in farming and, since these countries often experience low rainfall, there is very little left to go around. In Guyana, for example, where agriculture represents about one-third of GDP, farming consumes 97 percent of fresh water.
Where water is in short supply, farmers can use less of it but still increase their incomes by switching to high-value crops like fruits and vegetables and away from water-intensive but low-value crops like grains. This shift often requires investment in better irrigation technology. But in a system that charges so little for such a precious resource, there is not much incentive for investment.
As a result, in the poorest parts of the world, a limited supply of water means that poor consumers often pay100 times as much as farmers for the same water. That doesn’t have to happen. If water were used better in agriculture, more would be available for domestic use, saving lives in the poorest parts of the world. The way to get water to be used more efficiently is, not surprisingly, through markets.
Most users have a legal or implicit entitlement to water. Even in countries with poor legal systems, farmers typically have fixed or proportional quotas, or rights, available to them. Some farmers have quietly sold their rights (usually for one season) by forgoing their entitlement and allowing their neighbors to pump river water instead, a process that tends to move water to more efficient uses. Unfortunately, in most countries, such transfers are illegal. When trading does occur, it is inevitably local—say, between trusted neighbors on the same riverbank. Still, illegal swapping of water-use rights has been productive. The World Bank has estimated that, in India, the illicit practice has led to annual gains of over $1 billion in agricultural output.
Where rights have been legally defined to allow trading, local markets have developed. Some of these markets are simple exchanges with paper transactions; others allow trades across an entire river basin, conducted electronically on websites. Either way, most trades are short-term, taking place at times of water shortage and stress. In such cases, scarcity means that water is worth more, and the seller can forgo his entitlement if the water becomes more valuable than the profit from his crop.
The water buyer, if a farmer, will benefit from being able to maintain an abundant and healthy crop of consistent quality. But increasingly, buyers are municipalities, which want to help their residents and small businesses. A policy of trading makes not just economic but also moral sense: for the poor in cities and in the countryside, water reduces disease and death.
The environment gains too. In South Africa and Chile, dams, which had been planned to augment water supplies, became unnecessary as trading improved the efficiency of the water those countries already had. The decisions not to build dams saved tens of millions of dollars and probably lowered ecological stress. By contrast, China, with nearly half the world’s large dams, has no water trading. But to find the world’s most sophisticated and effective water-trading system, look to Australia.
A study by Henning Bjornlund and Jennifer McKay that examines trades in two Australian states, South Australia and Victoria, demonstrates how well a market-based system works. Trades in South Australia have doubled in volume since 1994, and prices have steadily risen. You can best see the progress through “Watermove” (www.watermove.com.au), a system that allows users to trade water online, lowering transaction costs.
In Victoria, dairy farmers purchased vast amounts of available water, while, in South Australia, vineyards, horticulture, and non-farming enterprises bought the bulk of traded water. The pattern in both areas has been a shift to higher-value production and more efficient water use, with a reduction in low-value farming, like growing cereals.
The annual benefit to trade in Victoria alone has been estimated at $100 million (U.S.). Water purchasers in South Australia were ten times more likely to use drip irrigation than water sellers.
Australia is allowing markets to work, helping farmers in ways that don’t distort prices and that bring water to its best uses—especially in times of drought. Although it’s still a work in progress, Australia’s transformation from a centralized allocation system to a flexible, market-oriented one has already reaped economic and environmental dividends. Other nations should pay attention.
Chart by MacNeill and MacIntosh
 R. R. Hearne, “Institutional and organisational arrangements for water markets in Chile,” in Markets for Water: Potential and Performance, ed. K. W. Easter, M. W. Rosegrant, and A. Dinar, (Massachusetts: Kluwer Academic Publishers, 1998).
 H. Bjornlund and J. McKay, “Aspects of Water Markets for Developing Countries: Experiences from Australia, Chile and the U.S.” Environment and Development Economics 7 (2002): 769-95.
 Bjornlund and McKay (2002).
 Water purchasers in South Australia were ten times more likely to use drip irrigation than water sellers, and three times more likely to use sophisticated irrigation scheduling techniques, because of the incentives created by trading. Bjornlund and McKay (2002).
 Department of Natural Resources and Environment, The Value of Water: A Guide to Water Trading in Victoria, December 2001, p. 17.