Water markets design and evidence from experimental economics

Abstract

Market mechanisms are gaining increasing acceptance all over the world as a way of making more efficient use of scarce water resources. Designing regulatory frameworks that ensure both inter- and intra-temporal efficient allocations is a daunting task, especially if supply is stochastic and there is ample storage capacity. In addition to defining tradable rights, specific provisions must regulate the use of reservoirs. Commonly, water statutes include provisions that establish asymmetries regarding the allocation of water, and market restrictions that ban water trading across different users. In this article, we use data collected in a laboratory to test two specific market regulations included in the 1999 Water reform in Spain. First, junior right holders are not allowed to buy water from senior users. Second, the law does not explicitly define water rights over units left in reservoirs for the following season. Results suggest that trading restrictions among water right holders lead to welfare losses for senior users. It is shown that removing this restriction would increase senior right holders’ benefits, without reducing those of junior users. Results show that defining water rights over saved units across periods would increase the average stock levels of reservoirs, and reduce market price instability. The lessons learned from the Spanish experience are applicable to settings characterized by unstable natural water supply and the availability of large storage facilities.