The Australian Markets Report (2008-2009) is an example of everything wrong with water market enthusiasm.
The primary objective of the Commission’s Australian water markets reports is to inform market participants about market structure, trading activity, prices and key policy drivers.
Providing this type of information to both direct and indirect participants in the market is an important step towards improving market performance.
Then it counts up the number and nature of water trades. From everything I’ve seen, Australia is the best example of having a water market for the purpose of having a water market. The metric of its success is whether it was a lot of water market or a little water market. This is all ridiculous. An assessment of a water market for the purpose of improving its performance should look at whether it does the things it was designed to accomplish. In towns with more trades, are farm mortgages more secure? In towns with more trades, do farmworkers have better working conditions? Do schoolchildren skip more? Do people choose to use smart irrigation timers? Do couples make love more often? There should be some policy goal, chosen for some purpose (secure the Delta, support east side farming, make food affordable, make meat expensive, some goal). And then we look at all the ways we could get to that goal, and perhaps a market is the least cost way to achieve that. If so, we choose a market as the way to accomplish the goal. Here, watch this applied to Cap and Trade.
In Cap and Trade, we want to reduce carbon emissions. Reducing carbon emissions is the goal. We do that because of conditions in the physical world. We set a cap on carbon emissions because we have science about how much the atmosphere can absorb this year without the oceans boiling over and the continents exploding. Right? A policy goal, set by real world conditions. Then, after science and people have agreed on that goal and set a cap, we look around for ways to do it. We could regulate emissions. We could tax emissions. We could create a market in emissions. Some people think creating a market in emissions would be the lowest cost way to get to our policy goal of reducing emissions. In that case, they like Cap and Trade. But we don’t want a cap and trade system because we LOOOOOOOVVEE trades. We haven’t won if there are more faster trades than ever before. We win if we hit the cap.
That’s the problem with all the talk about water markets. I never hear it paired with a goal. “I want a water market that gets me a smaller, robust farming system.” “I want a water market that gets me the cheapest possible water for urban users.” “I want a water market that gets me the most expensive possible water for urban users, because then they’ll conserve.” So far as I can tell, Australia wanted a water market because it wanted a water market, and we want a water market because Australia has one. If Australia wanted a water market because it would make farming easier, because it would move water to cities, because of something, you can’t tell from the Water Markets Report. It doesn’t measure anything but their market’s marketiness, which should only be of interest to the technicians tweaking it to accomplish some goal better. But they don’t even have a goal.
If you don’t have a goal for a water market, it will do ONE THING. It will seek out economic efficiency. Was that the goal in the first place? Who the fuck knows, we never talk about actual goals. Economists like to get rid of economic inefficiency, but some people call economic inefficiency their “jobs” and “towns” and “lifestyles”. (I was impressed to see Dr. Michael discuss this issue a while back.)
I’m not even opposed to water markets on principle. Once we have an actual goal, a market that was designed to support that goal could be the fastest cheapest way to get it. Or not. It almost certainly won’t be the fairest way to get that (because we aren’t starting with wealth spread evenly throughout society, so poor people will not be able to use the market to express their full preferences), so we should decide up front whether fairness is one of our design criteria. But all of that is a secondary, technical conversation. The first conversation should be to choose the goal.
On the public record 
Good point. Some things (exotic financial instruments come to mind) get traded on a market just so someone can make a buck. Nothing wrong with that, but no social utility, and possibly a danger to third parties. Especially in the provision of something as essential as water, legislative and political support for maintenance of of a market must spring from some perceived public benefit. Here are some goals we might achieve through better water markets in California:
1) Discourage waste, not just of water, but of other resources (land, fuel, fertilizer) by pricing agricultural activity appropriately.
2) Farming is a risky and cyclical business. Additional, stable sources of income from water sales (including indemnity type sales) can provide much needed financial stability. This helps, not hurts, farmers, workers, local communities, and lenders. Fallowing is a bone-headed solution that only rarely makes sense; and it scares the children and horses, which is why the most reactionary rural people are suspicious of markets.
3) There are many infrastructure improvements on farms and within water districts that could save a lot of water. If there is no economic return for building them, who will finance the construction, and why? Some think these things can simply be legislated; even if that were so, how could they be paid for? (Not the mention how such legislation would be drawn, how compliance would be measured, who would pay for the all-seeing Water Police, and in what millennium one intends to see any results.) Selling conserved water and reinvesting the proceeds suddenly makes more sense.
So, no, just as even the most ardent Austrian School folks grudgingly accept the tyranny of uniform weights and measures, few Californians think that markets will address every issue of provisioning water in a state where the people are in one place and the water is in another. But unlike Arizona or new Mexico, at least we have the water, and markets can be an awfully good way of protecting our environment without wrecking our economy.
I think economic efficiency is a good goal.
However, the initial infrastructure investment and water contracts had other goals, communities sprung up around them, etc. So suddenly switching the goal to economic efficiency creates some equity and social issues. These issues are much lower for within Valley trades.
Nice rant, and I agree that a water market per se should not be the goal.
Aussie water markets *did* lead to more skipping kids b/c they allowed more farmers to do what they want (sell water for $, buy water to grow), so you’re not quite right about *useless* there…
Markets in the Delta are another matter. Perhaps a cap and trade is a good idea, if you think that exports should be capped, but others might say that no exports is better. Thus no market.*
Bottom Line: Markets are good because they help us reallocate scarce resources at low cost (as noted above by comments). That outcome is worth skipping for…
* I have an interesting example of a “market” for the Delta *itself* here: http://www.ucowr.siu.edu/updates/144/4.pdf