The Use of Pricing and Markets for Water Allocation

This paper will argue that increased demand for water resources and higher cost of development of new water resources require a transition toward water systems that enhance conservation by adoption of efficient irrigation and application technologies, improving water delivery systems, and improving the efficiency of water allocation. This can be done by a transition from systems of water queuing based on historical water rights to systems of trading and efficient pricing. The design of water pricing has to consider political-economy and equity considerations and therefore we present alternative approaches — including active and passive trading with water markets, and various institutions including tiered pricing. Incentives to adopt cleaner and “greener” technology is essential for the improvement of water quality and we will present a framework for pricing water and inputs that affect water quality taking into account heterogeneity among water users and across locations. The analysis will use illustrations from various case studies including the California water market.