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It is useful to consider some general principles of water property rights reform; specifically, principles which are expected to determine the evolution of water property rights over time, consistent with the theory of Demsetz (1967). Two key principles are outlined below. The first principle is:
Any marginal increase in the hydrological realism of water rights will increase the efficiency of water resource allocation, assuming constant transaction costs.
That is, increasing exclusiveness (internalising externalities) will be beneficial where doing so involves no additional costs. The key point is that incremental improvements in water rights may be beneficial even where property rights remain substantial simplifications of reality. Property rights may be viewed as existing along a spectrum of realism, ranging from existing property rights up to the boundary of scientific understanding of hydrological systems. In practice, water rights (in any region of context) are likely to remain a significant distance from reality and scientific understanding.
As an example, consider the case of storage losses. The marginal losses associated with storing additional water in shared storage will vary significantly depending on the aggregate storage level and the prevailing weather conditions. However, a system that applies average losses based on historical averages may still generate efficiency improvements. Refining the system by adopting storage losses that vary with the storage level and the seasonal conditions may then yield further efficiency improvements, such as the approach adopted in the St George and MacIntyre Brook irrigation schemes in Queensland (Hughes and Goesch 2009b).
To this point any potential costs associated with adopting more realistic, and possibly more complex, systems of water property rights have been ignored. Water property rights reforms are likely to involve establishment costs, particularly from a water regulators perspective. Reforms may also lead to ongoing costs, such as increased transaction costs associated with trading water rights or making water use and storage decisions, although in practice the effect of water property rights reform on transaction costs can be ambiguous. The second key principle is:
Water property rights reforms should continue so long as the marginal benefits outweigh the marginal costs.
This is consistent with the idea of Demsetz (1967) who states, ‘property rights develop to internalize externalities when the gains of internalization become larger than the costs’ (Demsetz 1967, p. 340). Implicit in this principle is the idea that reforms in water property rights are likely to involve diminishing marginal returns. The closer water property rights are to reality, the smaller the marginal efficiency gains of further reforms. At the same time, the marginal costs may increase as property rights move closer to the boundary of scientific understanding, implying there exists some optimum level of property right realism.
Many have argued (see Young and McColl 2009) that the prevailing approach to water property rights in Australia is unlikely to embody an ideal level of hydrological realism. In general, the ideal level of hydrological realism would be expected to increase over time as water scarcity increases and as the scientific understanding of hydrological systems improves.
A number of anecdotal examples support the idea that water property rights may evolve according to the above principle. For example, the recent expansion of carryover rights, including their introduction into Victoria, has occurred largely in response to the dryer conditions, which have significantly increased the benefits of storage flexibility. A further example is the introduction of capacity sharing in St George, where the benefits of internalising storage capacity constraints and storage losses are especially high given the system’s highly constrained storage capacity and extremely high storage losses.