Technical Reports

Transaction costs and water reform: the devils hiding in the details. CRC IF Technical Report No. 08/08.

Martin, P., Williams, J. and Stone, C. (2008). Transaction costs and water reform: the devils hiding in the details. CRC for Irrigation Futures Technical Report No. 08/08.

Why it is so..?
Australia has embarked upon a program of water reform informed largely by proven economic concepts, coupled with good hydrological science. At the heart of this reform is the belief that creating trade-able entitlements to water, coupled with water law and governance reforms, will result in significant improvements in efficiency and our capacity to adapt to environmental stresses. The underlying hypotheses are well illustrated in theory, but as with most science moving from theory to full-scale implementation is fraught with unexpected complexity. The Chair and CEO of the Australian National Water Commission has highlighted aspects of the reform process that are advancing at a slower rate than is desirable. We look at his observations and ask “why is this so?”

This study is focused on rural and urban water users and their experience with the pursuit of ambitions that align closely with those of the National Water Initiative. Our approach was to understand impediments to more efficient and socially beneficial uses of scarce water, from a grass-roots perspective. We sought to understand the tardiness in achieving the benefits promised by water reform. Our approach reflects the CRC Irrigation Futures’ philosophy, which is to solve as well as to understand the challenges of harmonisation of irrigation systems. One result is that we can point to tangible improvements to which we have made a contribution. We discuss later in this report two locally proposed reform plans which have the potential to become national models for reducing impediments to effective reform.

The answer to the question ‘why is it so?’ that desirable innovations which ought in theory be enabled by the reforms in the National Water Initiative are taking root so slowly can be answered in a few words: transaction costs inhibiting the implementation of innovation. Our study demonstrates that the devil truly does lie in the detail, but not necessarily the detail that is being focused upon by the National Water Commission. Water law and governance, down to the level of water use on-farm or in the household or factory rests within a framework of economic, political and institutional structures that dictate the extent to which actual water use and its outcomes can reflect modeled expectations. This study suggests that reducing the gap between rational expectations of water trading and real world outcomes will require more exhaustive reform than has thus far been considered in the national water agenda.

This research uses a coupled systems approach to understand links between biophysical, economic and institutional matters. The central focus of our methodology is on the pattern of transactions between people and the environment, and between people. We asked those involved in water governance and water use what are the transactions that drive outcomes from water; what would the transacting pattern look like to deliver the desired outcomes; and what matters have to be adjusted to institutionally embed the desired transacting pattern? This investigation demonstrated that whilst in principle there are options for improving the performance of irrigation systems through innovation, in practice change is frustrated by institutional impediments, which generate high transaction costs, which in turn inhibit innovation in the use and management of water. These include:

1. Complexity associated with a large number of regulations, market instruments and organisations many of which are not water-focused;
2. The political and administrative interests associated with these arrangements, and the power associated with control of information and water as property.
3. Impediments to obtaining mandatory licenses, or alterations to planning and administrative arrangements (of which only some are water specific); and
4. Conflict from institutional competition and the absence of effective coordinating mechanisms. The conflicts are not confined to water trading or water governance, but reflect broader natural resource management institutional arrangements.

Our research has highlighted that the reform of transacting systems, rather than limiting the focus of reform to water institutions forming part of those systems, is a key concern. In this regard our methods are complementary to those used by the National Water Commission, but we suggest a broader set of reforms is needed to ensure that our national water policy goals are met.

What is being tested in irrigation is our national business model for sustainable resource management. The model that is institutionally embedded remains focused upon government as the central decision maker and lead investor. The model that is being advanced through water reform is one in which decisions of the private sector, and investments by the private sector, are the focus. A contest of philosophies is occurring in regional natural resource management, and in deliberations about Australia’s response to the challenges of climate and the decline of biodiversity. In the emerging alternative model government is a seed investor, facilitator and guarantor of institutional integrity. However this emergence is far from inexorable. The roles of government and the private sector are continually being redefined and intensively debated. The lack of a clear national business model for the environment is resulting in confusion and high transaction costs. We suspect that it is also resulting in wasted opportunities to efficiently conserve and to use what we have not yet destroyed.

At a regional level, our research has demonstrated once again the capacity of resource users to propose reforms that have national significance. In the rural setting addressing local impediments to sustainable water use has led to the proposal outlined in this report for a rigorous, streamlined approach to recognising gradations of management performance. This reflects a systematic approach to integrating regulatory and market instruments to change farming towards a greater emphasis on sustainable systems. In the urban setting, attempts to have the ecological, social and production values of irrigation recognised have led local stakeholders to propose an environmental services market for urban riparian zones. This reflects a sophisticated awareness of the challenges. It is a pioneering effort in reconciling pressures of urban consumption with the desire for conservation.

The next stage of our work will continue the emphasis on managing water as one element of linked natural and human systems. We anticipate that the result of the pursuit of the “Green Tick” recognition of different levels of farm environmental performance, and the creation of an urban environmental services market, will demonstrate that the methods we are using can contribute greatly to the advancement of triple bottom line sustainability in the use of water resources.

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CRCIF-TR0808-web.pdf ( 1,072kb )