Water Markets from an Economic Point of View

Recent droughts and the increase in food prices they trigger underscore that freshwater scarcity is bound to be a major challenge of the 21st century. Increased water demand due to population growth and rising living standards (with changing diets and lifestyles) strains available water resources. In spite of reports about an imminent water crisis, the world is not running out of water. Water is a renewable global resource of which there is more than enough. The major concern is that water is very unevenly distributed across and within countries. Water scarcity is thus primarily a local phenomenon, and fears mount that climate change might worsen an already bad situation in water-scarce areas. Excerpt UVA-GEM-0110 Rev. Dec. 13, 2012 WATER MARKETS FROM AN ECONOMIC POINT OF VIEW Recent droughts and the increase in food prices they trigger underscore that freshwater scarcity is bound to be a major challenge of the 21st century. Increased water demand due to population growth and rising living standards (with changing diets and lifestyles) strains available water resources. In spite of reports about an imminent water crisis, the world is not running out of water. Water is a renewable global resource of which there is more than enough. The major concern is that water is very unevenly distributed across and within countries. Water scarcity is thus primarily a local phenomenon, and fears mount that climate change might worsen an already bad situation in water-scarce areas. In this context, calls for better water management are heard. Water management used to be a matter of engineering and the supply side, especially associated with the construction of dams, canals, and so on. In recent years, there has been a shift toward economics and demand management. In this context, water markets are often featured as a tool to allocate water efficiently. There are water markets in Australia, some western U.S. states, Columbia, Chile, and South Africa. Markets are such an integral part of our lives that we seldom think about how they function. They are popular among economists because well-functioning markets are efficient and maximize overall economic welfare. Markets are ideal, decentralized tools to allocate resources particularly when they involve many people whose preferences are impossible to keep track of. Figure 1 displays the main withdrawers of water in the United States. However popular markets are, they are not a panacea. They do not necessarily work well under all circumstances. Well-functioning water markets presuppose a complex set of regulations and institutions. . . .