Scandinavian Working Papers in Economics

CERE Working Papers,
CERE - the Center for Environmental and Resource Economics

No 2017:2: Managing Water: Rights, Markets, and Welfare

Andrew L. Zaeske () and Chandra Kiran Krishnamurthy ()
Additional contact information
Andrew L. Zaeske: Independent Consultant
Chandra Kiran Krishnamurthy: CERE, the Department of Forest Economics, SLU and the Beijer Institute, Postal: Department of Economics, Umeå University, S-901 87, Umeå, Sweden

Abstract: This article investigates key aspects related to managing water resources, and explores their implications for economic efficiency: incomplete property rights; overallocation of water; the divergence between water entitlements and productivity of water use. These issues are explored in a production model with a single input, water drawn from a common source, and two main insights are offered. First, a novel result relating welfare and water entitlements is established, an equivalence between the socially optimal and legal assignment of water rights, via a set of social weights implied by the rights assignment. It is also shown that, for water entitlements for which the divergence between productivity and entitlements is substantial, no set of valid social priorities can lead to the socially efficient allocation. Second, considering a hypothetical water market with an endogenous price, it is found that trade in water is unable to eliminate allocative inefficiency, and that taxes have unexpectedly moderate effects on trade and welfare, with the majority of tax shifts canceled out by changes in demand. In addition, trade is not effective at facilitating efficiency-enhancing reallocation of water under scarcity when entitlements diverge substantially from productivity. The results here highlight important new connections between welfare and water entitlements and the limitations of market-based instruments under incomplete property rights, and have implications for designing property rights regimes for managing water under scarcity.

Keywords: markets; water rights; allocative efficiency; social welfare; copula

JEL-codes: D61; Q10; Q25

48 pages, March 22, 2017

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