3.2 Requirements for the efficient operation of a water market
3.2.1 Water rights regimes
A water right is "a collectively recognised access to water resources under specific conditions defined in the right, such as point of diversion, season, location and purpose of use, and quantity of withdrawals" (Saliba & Bush, 1987: 1). According to Sampath (1992), water rights are generally based on a variant or combination of the following three systems:
riparian rights, prior (appropriative) rights, and as was previously discussed, public allocation.
Under the riparian rights doctrine, water rights are linked to land ownership: anyone who possesses land next to a flowing river or stream may make reasonable use ofthe resource as long as enough is left for downstream users. The location to which the water is diverted must be adjacent to the water source otherwise the diversion is prohibited. Regions where water is relatively abundant tend to make use of the riparian rights doctrine (Holden and Thobani, 1996). The rights entitle the landowner to a percentage of the water available for irrigation.
This structure of water rights spreads the risk of variability in water supply equally among the shareholders (Nieuwoudt, 2000).
Prior rightsare based on the appropriation doctrine, under which the water right is acquired by actual use over time (Sampath, 1992). Quotas are allocated to users on a first-come first- served basis. Diversions of water under this regime are subject to the 'use it or lose it' rule.
For this reason 'sleeper' rights do not exist. This system is used extensively in the western United States of America (USA) (Holden and Thobani, 1996; Nieuwoudt, 2000). Rights can also be classed as senior rights and junior rights. Those users who established a beneficial use of water earliest are given senior rights over users who established use later. This provides certainty in supply as senior rights are met before junior rights (Nieuwoudt, 2000).
According to Saliba and Bush (1987: 23), property rights for water resources must have the following characteristics: they must be well-defined and completely specified in the unit of measurement, reliability, priority, and enforced so that all individuals know the privileges and restrictions that a water right provides and requires, and also know the penalties for any violation. In addition. in large river valleys where downstream users are dependent on the return flows of upstream users, the right should account for these return flows. One way to account for return flows is to restrict water transfers from one water district or area to another to only the portion of the right that is actually consumed. However, this situation requires measuring of water, which can often be costly and difficult to implement. Further, rights can only be transferred from up-to down-stream in the western USA so that the users are ultimately unaffected. Rights need to be exclusive so that the benefits and costs associated with water use and transfer decisions accrue directly to the decision maker. They must also be comprehensive so that all value generating aspects of water can be represented by water rights, such as water quality and instream flows. Rights should be transferable, so that water
right holders can respond to differing conditions and attractive offers by higher value users.
This accommodates changes in water uses from low value to high value uses. The right can be actual ownership, a usufructuary right, or a contractual right of use. The right must be specified in perpetuity or be of sufficient length to be valuable to a user (Simpson, 1992). If rights and titles are secure, Government, or preferably courts, could have jurisdiction over transactions.
3.2.2 Administration, infrastructure, and information issues
A water market requires an efficient administrative system that will prevent abuses of the system and maintain the proper chain oftitle over the water rights. Anauthority is necessary to legally sanction water trading, ensure legal formalities are adhered to, register the right, enforce legislation and regulations, and resolve disputes among users (Armitage, 1999).
Water markets need infrastructure, as they can only be instituted where water can be delivered. Infrastructure, such as dams and canals, needs to be established in areas where water does not naturally How and where demand for water exists. Infrastructure, however.
can only be established where the users of water can bear the cost of creation of new infrastructure. Any improvements needed for the physical transfer ofwater from the place of use of the seller to the place of use of the buyer should be part of the transaction cost borne by the parties involved in the transfer. Information regarding water prices, trades, and availability should be readily available to potential buyers and sellers. Hydrological information is also required to permit the right to be defined. Different types of information are necessary for rational decision-making by water rights holders, such as information on legal and hydrological characteristics of water rights, and the cost of alternate means of obtaining water. This requires the existence of good data and monitoring systems (Louw,
2001: 52).
3.3 Sources of market failure
Water markets seem to be a practical solution to many water allocation problems, but some countries have not established them. The economic argument against trading water rests on the perception of market failure, which arises because of varying factors. One such factor is high transaction costs which are attributable to the setting up of a new legal, regulatory and institutional framework; defining, measuring and enforcing water rights; the identifying of potential beneficial and profitable opportunities for trades (information costs); the costs of negotiating the transfer and administrative costs surrounding the transfer (contracting costs);
the cost of monitoring possible third-party effects and other externalities resulting from a transfer; the infrastructure costs of monitoring, mitigating and eliminating third-party effects;
and making necessary changes in water intakes and conveyance infrastructure to effect the transfers (Holden and Thobani, 1996; Rosegrant and Binswanger, 1994; Young, 1986).
Table 3.2 overleaf summarises who bears these costs.
Under administrative allocation, all costs are borne by the authority or governing body within the jurisdiction of the authority. In a market system, the water rights users bear the costs of identifying opportunities and negotiating the transfers. The costs of conveyance and mitigating third party effects fall on the buyers, and they would attempt to find those trades which minimise the total of purchase price, conveyance and mitigation costs.
Table 3.2: Transaction costs under alternative water allocation systems.
Allocation Process Costs of
Identifying opportunities Negotiating transfers
Monitoring third-party effects Conveyance
Mitigation of third party effects
Administrative Authority Authority, Users
Authority Authority Authority
Tradable Rights Users Users Authority
Buyer Buyer Resolving conflicts Authority, Courts, Users
Source: Adapted from Rosegrant and Binswanger, (1994).
Authority, Courts, Users
On the other hand, administrative allocation may be subject to political pressures and authorities may not have the same incentive to minimise the total cost of the transaction as the buyer would (Rosegrant and Binswanger, 1994). In addition, a central authority may not have access to the same information available to the individual users of water and cannot make a decision based on as much information as a market would facilitate.
The institutional arrangements around which a market is designed and the regulations that it is governed by, have a major impact on transaction costs (Armitageet aI., 1999). Excessive regulation can create high transaction costs, which greatly reduce the benefit ofwater trading (Rosegrant and Sch1eyer, 1994). Conversely, if there is very little regulation, then unacceptable costs could be placed on the environment and third parties (Saliba& Bush, 1987: 236). In addition, with little regulation, transacting may become too risky.
administrative problem in water markets. These externalities take the forms ofaltered return flows, changed groundwater levels, and water quality changes. A water market transaction will guarantee that both buyer and seller are made better off, but some third parties will gain and others will lose. Gains can be from increased instream flows between the seller and the buyer in the case of an up- to down-stream transaction and from a change in irrigation activities which increase return flows or maintain water quality. Losses can occur when reduced instream flows are experienced by users downstream from the buyer in the case of a down- to up-stream transaction and also from changes in irrigation activities which decrease return flow or reduces water quality. These third party effects need to be accounted for in the decision making process of the transacting parties and the losers should be compensated so that no one is worse off as a result of the transfer (Howeet al., 1986). These effects need to be identified and quantified as accurately and quickly as possible so that adjustments can be made and/or compensation be paid and the transfer can be completed without excessive transaction costs. This can be partially overcome by trading only the consumptive use by water users. Consumptive use of different irrigation methods and different crops in various regions could be estimated by hydrologists and some standards could be prescribed by a public or private water authority, where necessary, to facilitate transactions.
There are also issues ofreturn flows, public goods aspects, and equity considerations, which oppose markets. Other arguments have been identified by Rosegrant and Binswanger (1994).
These authors add that the high costs of investment needed to develop markets are exacerbated by the relatively low value of water in developing countries. They also identify externalities as a major problem in the establishment of water markets.
Since these problems exist and are not easily overcome, public institutions are required in some aspects of a water market. Some of their roles are protection against third party impairment from trades and to resolve conflicts among water users (Rosegrant and Binswanger, 1994). These institutions need to be decentralised so that they can make use of local information, which is unique to certain areas, in order to make informed decisions.
Despite the many obstacles to water markets, many countries have successfully introduced them, such as the western USA, Australia, Pakistan, Chile and Mexico (Holden and Thobani, (1996); Nieuwoudt, (2000); Bjornlund and McKay, (1996)).
The following chapter discusses the survey methodology. Itoutlines the hypothesised model and describes the statistical techniques that are used in the estimation of the models. The survey areas are also introduced and described at the end of the chapter.
CHAPTER FOUR STUDY METHODOLOGY
This chapter is arranged in three sections. The first section outlines the hypothesised economic model of water transfers. The second section describes the statistical techniques that are used to estimate the models. The third section introduces and discusses the study areas of the Lower Orange and Crocodile Rivers.