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Water and Australia's future economic growth

Date



Rowan Roberts, Nicole Mitchell and Justin Douglas1

Water is critical not only to life, but also to economic growth and environmental outcomes. This article examines how water in Australia is currently allocated and used, and explores some of the consequences of current water management arrangements. Concluding that the current allocation of water gives rise to both technical and allocative inefficiencies, the article examines the importance of water markets. Water markets can deliver numerous benefits to individuals, communities and the economy more broadly, as well as providing a mechanism for governments to address environmental concerns. Despite an ongoing water reform agenda, Australia does not have well-functioning and complete water markets. The National Water Initiative (NWI) provides a framework for the continued development of water markets in Australia but the implementation of the NWI will require ongoing commitment from governments and other participants in the water market.

Introduction

Water is a valuable resource and is essential to sustaining the wellbeing of Australians. The availability of water has influenced the pattern of economic development in Australia. All of Australia’s major cities and most of its towns are located where water can be extracted for human consumption, as well as for productive uses. Water is an important input to almost every industry. Throughout Australia’s history, the link between water availability and agricultural production has been repeatedly demonstrated. All stages of mining production rely on water, either for exploratory drilling, production or site rehabilitation, as well as during downstream processing. Many manufacturing processes and service industries also use water as an essential input.

Water is clearly essential for Australia’s economic prosperity. However, Australia is characterised by extreme climatic variability and has the lowest average rainfall of any inhabited continent (Bureau of Meteorology 2006). Moreover, the sustainable extraction level for many of Australia’s water resources is being approached or exceeded.2 The consequences of this are already evident in reduced water quality, salinity and threatened biodiversity. These problems are primarily environmental, but they can also have adverse consequences for economic production.

The emergence of these problems has raised concerns that the availability of water could place a constraint on economic growth. Some would argue that these constraints are already emerging. There is a related concern amongst some in the community that because of the scarcity of water, continued economic growth can only be achieved at the expense of the environment.

However, the finite nature of our water supplies does not have to imply reduced economic growth or ongoing environmental degradation. Rather, the fact that water resources are scarce means that water, like other limited inputs to economic production, needs to be used efficiently and allocated to its highest value uses in order to improve both economic and environmental outcomes. This paper starts by examining the current allocation of water in Australia and concludes that it is unlikely that water is currently used or allocated efficiently. This means that there is scope to improve the allocation of water in such a way as to achieve economic growth and ensure water for the environment.

In general, markets are an efficient mechanism for ensuring that scarce resources are efficiently allocated. The next section of this paper discusses the potential benefits of expanding the scope and role of water markets in Australia. These include improving the allocation of water across industries, improving the efficiency with which it is used within industries, providing incentives for investment in water infrastructure and providing a mechanism for the provision of environmental water by governments.

The Council of Australian Governments (COAG) has agreed on a number of reforms aimed at expanding the Australian water market, including the National Water Initiative (NWI) agreed in 2004. The NWI aims to increase water trade by seeking to define water property rights more clearly and remove institutional and regulatory barriers to trade in water. The paper examines the effectiveness of the current Australian water market and outlines the progress of these reforms.

The paper finishes by discussing some of the key risks and challenges that will need to be overcome if the benefits from expanding water markets are to be realised.

How is water currently allocated and used?

There are two separate issues in relation to how water is allocated and used. The first is how much water is extracted from a water system and whether this is sustainable. The second issue is how productively the extracted water is used.

Overallocation (how much water is used)

Historically, water has been allocated on an ad hoc basis with little regard to its scarcity (see Box 1 for an overview of the history of water allocations). As a result, many water systems are over-allocated, in that the total volume of water that can be extracted by entitlement holders exceeds the sustainable level of extraction for that system. For example, it is estimated that in New South Wales, licences and water allocations equal 120 per cent of total available water resources (Melville and Broughton 2004).

Many water users have historically held licences providing for higher water extraction amounts than they have actually used. For as long as the actual amount extracted was below the sustainable level of extraction, this was not a problem. However, as irrigators have increased production and used more of their licences, over-allocation has led to overuse, in that the total volume of water physically extracted from the system exceeds the sustainable level of extraction. Also contributing to the emergence of overuse is the fact that as individual irrigators adopt practices such as drip irrigation to increase the efficiency of their water use, less excess water re-enters the water system.3

The over-allocation and subsequent overuse of river systems has left many of Australia's water resources under significant pressure. Of Australia's 325 surface water basins, 84 are currently overused or close to it. These systems account for about 55percent of total water use in Australia. The areas under the most pressure from overuse are predominantly located in the eastern States, with the Murray Darling Basin showing the greatest signs of pressure (NLWRA 2002).

Overuse can have significant environmental and economic consequences. Overuse results in unhealthy rivers and a loss of biodiversity through inadequate environmental flows. For example, the Barmah-Millewa Forest in New South Wales and Victoria is home to numerous threatened plant and animal species. These include river red gums, which depend on regular flooding from the Murray River. Decreased flooding in recent years has led to declining forest health and decreased waterbird-breeding and fish-spawning (Living Murray Initiative 2005).

Overuse also results in poor water quality, with problems such as algal blooms and increased water salinity. Degraded water quality can impose significant costs on agricultural users. For example, high salinity levels reduce irrigation crop yields and can cause loss of arable land (MDBMC 1987). The impacts of salinity illustrate that over-allocation can have long-term consequences for the productivity of land and water and pose a threat to potential economic growth.

Additional water to support economic growth and/or to address environmental problems cannot be ‘created’ easily or at low cost.4 The BCA
(2005) notes that over-allocation of water and resulting surface and groundwater stress is sometimes used to argue against higher population or higher economic growth. However, despite significant over-allocation in some regions, it would be wrong to assume that strong economic growth and good environmental outcomes are mutually exclusive. Poor environmental outcomes do not indicate economic growth is not compatible with environmentally sustainable water use. Rather, they indicate problems with the way that water is currently allocated and used.

Box 1: An overview of water rights

In the Australian colonies, water law was based on English common law. The common law did not define the water itself as property — rights to water were attached to land and could not be bought or sold separately to the land.

The common law had two different schemes to allow access to water. Firstly, for surface water in a river, ‘riparian’ rights were given to those who occupied land immediately next to rivers such that riparian owners could use the water for ordinary and domestic purposes provided they did not substantially affect the quality of the water in the river. If water was taken for other purposes, such as manufacturing or irrigation, it had to be returned to the system largely unchanged in quantity and quality.5 For all other categories of surface or ground water, the owner of the land had an unrestricted right of access to the water.

However, in the 1870s and 1880s, it was recognised that common law principles would not provide secure water supplies and the colonies began passing legislation to give the right to use and control the water in all rivers and lakes to the Crown.

At Federation, with the exception of section 100, the Constitution did not address the issue of water resources and the power to control water resources thus remained with the States. The Commonwealth’s only powers over water resources came from its power to legislate for defence, trade and commerce, and external matters.

Water allocation arrangements throughout the 20th century were complicated, involving statutory riparian rights for certain users, water rights in irrigation schemes, and licences and permits. The exact details and tenure of these arrangements differed across States, but in general terms these allocations provided a right to take and use water, rather than a property right to the water itself. While water agencies had the power to change or cancel licences, this did not occur and in most circumstances water licences came to be viewed by holders as rights in perpetuity.

By the 1970s it became evident that some water systems were over-allocated, in that the total volume of water that could be extracted by entitlement holders exceeded the environmentally sustainable level of extraction for that system. A number of reforms followed in most States, including moving to volumetric allocations which varied with available water each year, the powers to suspend allocations during water shortages, embargoes, new water legislation and the beginning of water trading.

However these initial reforms did not meet the demands for the security of water for consumption or the growing need for water to be allocated to the environment to restore water quality and repair ecosystem damage. As a result, further reforms were instigated through the Premiers’ Conference in 1994, focusing, among other things, on institutional reform including the creation of secure and clearly defined water entitlements, the separation of water entitlements from land title and the trading of water allocations. By 2002, COAG recognised that some impediments remained to achieving the 1994 reform objectives and it was in this context that the National Water Initiative was initiated and agreed by States and Territories and the Australian Government in 2004.

(Sources: Tan, PL 2004; Melville and Broughton 2004)

How water is used

The vast majority of water in Australia is used in agricultural production. As can be seen from Chart 1, two-thirds of the water consumed in the Australian economy is used in the agricultural sector. The recent drought illustrated the dependence of this sector on water availability — in 2002-03, farm output fell by $3 billion from 2001-2002 levels, leading to a reduction in GDP of around 1 per cent and causing difficulties for farm families and communities (Lu and Hedley 2004).

Chart 1: Water consumption

Chart 1: Water consumption

Urban water use accounts for less than one-third of all water use in Australia. Despite declining per capita urban water use, as of early 2005, water utilities in almost every urban area had imposed domestic water restrictions in response to increasing pressure on urban water resources.6 These urban water restrictions place significant economic costs on households and urban industry.7 For example, the Water Services Association of Australia (WSAA) estimates that since 2002, water restrictions have cost the ACT $71million (WSAA 2005).8 In other cities, with much larger populations and a higher proportion of water-dependent industries, the economic cost of water restrictions is likely to be much higher.

Clearly water availability impacts on the economy. However, it is not only total water availability that matters to economic growth, but also how the available water is distributed and the efficiency with which it is used.

Water productivity

Water productivity relates to how much water is used to produce a given output, which can be measured as production (measured in terms of economic value added) per megalitre of water used.9 Water productivity is influenced by the way in which water is used to produce an output (technical efficiency), and how water is allocated between and within industries (allocative efficiency).

Technical efficiency

For individual businesses, water productivity can be influenced by factors such as wastage, evaporation, leakage and the production technologies used. For example, a farm business that grows a crop using drip irrigation is likely to have greater water productivity than one that grows the same crop using flood irrigation. This type of productivity is sometimes referred to as technical efficiency since it concerns the amount of the desired output (economic value added) that can be produced using a given quantity of input (in this case water).

Due to technical inefficiency, a significant amount of irrigation water is lost through seepage or evaporation before it is ever put to use. On average, only 77 per cent of water extracted reaches the final user. In some circumstances, this proportion can be as low as 41 per cent. The variation in the percentage delivered reflects delivery techniques ranging from open channels to fully piped reticulation systems (NLWRA2002). Once delivered, storage evaporation from dams and other storages can result in further significant losses (BCA 2005).

This wastage could be reduced through piping, channel lining and coverage, or the introduction of drip irrigation (Pratt Water 2004). However, there is currently little incentive to invest in water-saving infrastructure because the opportunity cost of wastage is not recognised due to the restricted and limited nature of the water market. Put another way, the ability to sell ‘unused’ water or excess water from increased technical efficiency cannot be realised.

Allocative efficiency

For the economy as a whole, it is also poss
ible to identify a second type of water efficiency, which relates to how well water is allocated across different industries and uses. Allocative efficiency is achieved when it is not possible to increase the value added for the economy as a whole by transferring water from one activity to another. Conversely, if water is not being used in a manner that is allocatively efficient, then it is possible to improve economic outcomes by transferring water to uses where it can make a relatively larger contribution to GDP.

At an aggregate level, water productivity is also referred to as the average product of water. This average product of water can vary significantly across industries, as well as within industries. As can be seen in Charts 2 and 3 below, the differences in average product between industries and even between commodities in the irrigated agriculture sector are dramatic. These differences reflect a broad range of factors, including significantly different inputs of capital and labour, which can be substantial. The rice and cotton industries, which use over half of all agricultural water, have a much lower average product than horticulture. In fact 12 per cent of irrigation water produces 50percent of the value of total agricultural production (ABS 2004).

For allocative efficiency to exist, the marginal product of water should, subject to transport, treatment and transactions costs, be equal across all of its different uses.10 Data on the marginal product of water are not readily available and the averages shown in Charts 2 and 3 do not show the marginal product of water in each industry.11 Nevertheless, the extent of the differences between the average product of water across industries is so large as to suggest that the marginal product of water is unlikely to be equal across its various uses. It seems reasonable to conclude that a reallocation of water between industries could improve the allocative efficiency of water use across Australia and thereby yield substantial benefits to the economy.

Chart 2: Gross value added per megalitre
of water used in selected industries

Chart 2: Gross value added per megalitre of water used in selected industries

Source: ABS, 2004.

Chart 3: Gross value added per megalitre
of water used in irrigated agricultural production
12

Chart 3: Gross value added per megalitre of water used in irrigated agricultural production

Source: ABS, 2004.

Notably, the efficient allocation of water is constantly changing. Movements in world commodity prices, exchange rates, fuel and transport costs, labour costs and weather can all influence the economic value added in a particular industry and hence the marginal product of water in that industry. Thus it is important that mechanisms exist to ensure that water can move to its highest value uses.

In this context, a prerequisite for improving wellbeing is ensuring that water resources can move easily to their most productive uses. Efficiently functioning water markets are the key to this objective.

The benefits of water markets

There is evidence to suggest that water in Australia is not currently used in a way that is either technically or allocatively efficient and that the current allocation of Australia’s water resources poses both economic and environmental threats. Markets can provide incentives that address these inefficiencies and a mechanism which enables both sustained economic growth and improved environmental outcomes.

By making the value of water explicit, water markets provide an incentive to increase the technical efficiency with which water is used, even if very little water ends up being traded. This is because water users gain the opportunity to sell any water that they do not use, either by selling a share of their entitlement permanently or by leasing out their unused annual allocations.

This price signal provides incentives for improvements in water infrastructure that reduce wastage, leakage and evaporation and encourage water to be stored more cost-effectively, potentially increasing the amount of water that reaches end-users. The Bureau of Transport and Regional Economics found that water trade is one of the key factors influencing investment in irrigated agriculture infrastructure in the lower Murray-Darling Basin (BTRE 2003).

Incentives to invest in improved water infrastructure will exist wherever the value of the water that can be saved is greater than the cost of the investment. In the past, investment in on-farm water infrastructure has been financed by individual water users and off-farm infrastructure has often relied on government involvement. However, water markets will provide new opportunities for private sector investment in water infrastructure. Saved water could be sold or leased to finance private investment, or investors could share in water savings in return for their investment. It is likely that these incentives for private sector investment in water infrastructure will become increasingly important in future as factors such as demographic change put increasing pressure on government budgets (Treasury 2004).

Water markets will improve the allocative efficiency of water use. Both buyers and sellers stand to benefit from water trade. Where water is being used to generate only low levels of economic return, water markets will provide users with the option of selling their water. For sellers, the revenue from the sale of water can supplement farm income and provide capital for other on- or off-farm activities, injecting additional income into regional communities. At the same time, farms and businesses that can use water to generate high rates of economic return, but are currently limited by their inability to obtain more water, will benefit by being able to buy water to increase production. Well-designed water markets will allow buyers and sellers to trade either permanent entitlements or annual allocations depending upon their individual preferences and needs.

Beyond these initial benefits to buyers and sellers, trade generates dynamic benefits for the broader economy because water can be put to different value uses by different users. Economic benefits accrue because the price signals created by markets provide incentives for water to flow to its highest value uses, increasing wealth and generating economic activity. The ability to sell water can facilitate exit from industries that are declining or undergoing consolidation, which may otherwise be difficult. Water purchases can facilitate the growth of viable industries, augmenting regional economic activity and generating increased employment. Further dynamic benefits could be realised as price signals provide water users an incentive to invest in the development of new water-saving technologies.

Water markets can also lessen the effect of reductions in water availability, reducing the individual and aggregate economic impacts of climate variability. For example, there is evidence to suggest that inter-regional trade would significantly mitigate the economic impact of reduced water supply in the southern Murray-Darling Basin (Peterson et al 2004). This will be important if, as is predicted by some, climate change leads to a reduction in rainfall over the south-east of Australia (Pittock 2003). Similar analysis indicates that trade between urban centres and major irrigation districts reduces economic losses from reduced water supply (Dwyer et al 2005).

Another means by which water markets can improve the management of climate variability is through encouraging the development
of innovative financial products. The SFE State Water Indexes that are currently being developed in a partnership between the New South Wales State Water Corporation and the Sydney Futures Exchange are an example of such innovation.13 As water markets develop, it is likely that other products such as forward contracts or futures and other derivatives will also develop. Such products should allow agricultural and other businesses to manage their drought risk better and thereby enhance their long-term economic viability.

There may be some concern that communities dependent on water-intensive industries may suffer where water trading leads to structural changes in the local economy. However, a high rate of structural change does not necessarily result in a low rate of income or employment growth, particularly if relatively inefficient businesses or practices are replaced by more efficient ones (CSIRO 2005). The CSIRO has found that on a community level, the effects of adjustment are smaller than might be expected, as opportunities often emerge to replace agricultural income with income derived from providing other services. On an individual farm level, those who adapt quickly to the opportunities provided by water markets can benefit significantly.

As noted above, as well as ensuring that water-dependent industries can continue to grow, there is also a need to restore some water to the environment. Water markets can facilitate this by allowing governments or environmental organisations to purchase water for environmental purposes. This mechanism allows governments to respond to changing community demands in relation to environmental protection, and places an explicit value on the cost of its provision. Notably, as indicated earlier, these improved environmental outcomes do not need to come at the cost of economic growth. Indeed, with allocative and technical efficiency improvements occurring within well-designed water markets, it should be possible to raise economic growth and improve environmental outcomes.

To illustrate the potential for water markets to make both the environment and the economy better off, consider 10 ML of water that is currently being used to produce $100 of economic value added per ML (or $1,000 of economic value added in total). If 8ML of this water were to be sold to an alternative user who could produce $200 of value added per ML, the water would now be generating $1,600 of value added (8MLנ$200=$1600). The remaining 2 ML could then be purchased for or given to the environment so that the economy would be $600 better off and the environment would receive an additional 2ML.

The Australian water market

The Productivity Commission (2005) found that water reforms since the 1994 Premiers’ Conference agreement have ‘encouraged more efficient use of this scarce resource and generally improved environmental outcomes’. However, they also note that ‘there is still much more to do to achieve efficient and sustainable water use across Australia’. The National Water Commission has also noted the importance of ongoing water reform, in particular as it relates to water trading (NWC 2005). Despite the many benefits of water trade, the creation of effective water markets has not proved an easy task.

Currently, there is not an effective national water market. In some instances, there are not even fully functioning state water markets. Instead, the majority of permanent trade in water occurs within catchments and even where this can occur, it is often not substantial. For example, trade in permanent entitlements in the southern Murray Darling Basin is, on average, only 1-2per cent of total allocations (Peterson et al 2004) and water still cannot be traded interstate beyond a limited pilot area. Moreover, water is rarely traded between competing uses, but is more likely to be traded between producers of similar commodities.

Underlying the limited and fragmented nature of the water market is the complexity of current water property rights. As outlined in Box 1, the legacy of historical water allocation policy is a complex system of licences, permits and irrigation rights that vary between States and even between regions within States. These mechanisms imply a right to access water, which although generally technically of limited duration, is made more ambiguous as a result of custom and past practice. These factors contribute to confusion and misunderstanding about water property rights.

The expansion of the Australian water market requires property rights to be clearly defined in order for transparent and effective water trading-systems to be implemented. Providing clarity over the definition of property rights is one of the primary objectives of the National Water Initiative (NWI), which was agreed in June2004 by the Australian Government and most States, with the aim of developing ‘a nationally-compatible market, regulatory and planning based system of managing surface and ground water resources for rural and urban use that optimises economic, social and environmental outcomes’ (COAG 2004; NWI clause 23).

In addition to establishing a clearly defined property rights framework for water, under the NWI, States have agreed to the expansion of water markets to allow greater permanent trade in water; more transparent and comprehensive water planning; and the allocation of water to meet specific environmental outcomes.

However, despite the benchmarks set by the NWI, it is likely that expanding the water market in Australia will not be straightforward. While States have agreed under the NWI to the expansion of water markets for greater permanent trade in water, progress has been constrained by a number of practical challenges.

As water management occurs on a state level, and States have different water entitlement regimes, institutional differences between States inhibit water trade. For example, water entitlements in different States have different risk attributes, which determine the average quantity that the entitlement holder receives and the variability around that average.14 This difference between products has to be accounted for before interstate trade can take place. The need to convert one product to another across state boundaries could act to impede the development of a national water market.

Australia’s experience with trying to establish and implement a uniform rail gauge, which took more than a century after Federation, highlights the difficulties that can be involved in achieving national consistency. It will be critical for the Australian economy and the environment that the differences of approach inherent to each of the States’ existing water management regimes are resolved expeditiously.

Conclusion

Australia’s current system of water allocation results in environmental damage and lower economic growth than would otherwise be the case. The environmental damage caused by the current allocation of water threatens not only habitat and biodiversity but also rural output through degraded land and water quality. Even where systems are not over-allocated, problems arise as a result of the misallocation of water between industries and regions. This results in excessive water wastage and disincentives to invest in water-saving infrastructure, and limits potentially economically beneficial changes to industry composition.

Water markets could improve economic outcomes through providing price signals that allow water to flow to its highest value use and encourage investment in water-saving infrastructure. A more efficient allocation of water could potentially increase the amount of water available and the operation of the market would enable the purchase of the desired amount of environmental water. Water trade can also lessen the aggregate and individual impacts of climate variability.

The NWI sets benchmarks for the expansion of nation
ally compatible water markets and an increase in the permanent trade in water, which have the potential to deliver significant economic and environmental benefits. However, challenges remain in implementing these objectives and a significant commitment is required from all governments and stakeholders. This commitment will be critical to achieving an efficient allocation of water in Australia and obtaining the subsequent economic and environmental benefits.

References

ABS 2004, cat no. 4610.0, Water Account, Australia, 2000-01, Australian Bureau of Statistics, Canberra.

BCA 2005, Infrastructure, Action Plan for Future Prosperity, Business Council of Australia, Melbourne.

BTRE 2003, Investment Trends in the Lower Murray-Darling Basin, Working Paper 58, Bureau of Transport and Regional Economics, Canberra.

Bureau of Meteorology 2006, Canberra viewed 6 January 2006,

www.bom.gov.au.

COAG 2004, Intergovernmental agreement on a National Water Initiative Between the Commonwealth of Australia and the Governments of New South Wales, Victoria, Queensland, South Australia, the Australian Capital Territory and the Northern Territory, Council of Australian Governments, Canberra.

Crean, J, Jayasuriya, R & Jones, R 2001, ‘Regional agricultural implications of environmental flows in the murrumbidgee valley, Australia’ Water Policy Reform: Lessons from Asia and Australia, Proceedings of an International Workshop, Bangkok, Thailand, 8-9 June.

CSIRO 2005, Managing Change: Australian structural adjustment lessons for water, September 2005, Adelaide.

DWLBC, Department of Water, Land and Biodiversity Conservation South Australia, Adelaide, 2006, viewed 10 January 2006,

http://www.dwlbc.sa.gov.au/murray,.

Dwyer, G, Loke, P, Appels, D, Stone, S & Peterson, D 2005, Integrating rural and urban water markets in south east Australia: Preliminary Analysis, OECD Workshop on Agriculture and Water: Sustainability, Markets and Policies, Adelaide.

Douglas, R, Dwyer, G & Peterson, D 2004, ‘Activity gross margins and water reform’, Connections, Autumn, Melbourne.

Living Murray Initiative 2005, Barmah-Millewah Forest Asset Environmental Management Plan for 2005/2006, Murray Darling Basin Commission, Canberra.

Lu, L & Hedley, D 2004, ‘The impact of the 2002-03 drought on the economy and agricultural employment’, Economic Roundup, Autumn, Treasury, Canberra.

MDBMC 1987, Murray-Darling Basin Environmental Resources Study, Murray-Darling Basin Ministerial Council, Canberra.

Melville, F and Broughton, P 2004, Trading in water rights, water and the Australian economy, Growth, 52, Committee for Economic Development of Australia, Melbourne.

NLWRA (National Land & Water Resources Audit) 2002, Australians and Natural Resource Management, Natural Heritage Trust, Canberra.

NWC 2005, Water trading vital to national water reform, National Water Commission, 9December 2005, Canberra.

Peterson, D, Dwyer, G, Appels, D & Fry, J 2004, Modelling Water Trade in the Murray-Darling Basin, Staff Working Paper, Productivity Commission, Melbourne.

Pittock, B (ed) 2003, Climate Change: An Australian Guide to Science and Potential Impacts, prepared for the Australian Greenhouse Office, Canberra.

Pratt, W 2004, The Business of Saving Water: The Report of the Murrumbidgee Valley Water Efficiency Feasibility Project, Pratt Water, Victoria.

Productivity Commission 2005, ‘Review of National Competition Policy reforms’, Productivity Commission Inquiry Report, no. 33, 28 February 2005.

Tan, P 2004, ‘Legal issues relating to water use’, Issues Paper No. 1, Murray-Darling Basin Commission Project MP2004: Agriculture and Natural Resource Management in the Murray-Darling Basin: A Policy History and Analysis, Faculty of Law, Queensland University of Technology, Queensland.

Treasury 2004, Australia’s Demographic Challenges, Canberra.

WSAA 2005, Australia’s water, sharing our future prosperity, Water Services Association of Australia, Melbourne.

1 The authors are from Industry, Environment and Defence Division, the Australian Treasury. This article has benefited from comments and suggestions provided by Frank Di Giorgio, David Ellis, David Gruen, MaryanneMrakovcic and Malcolm Thompson. The views in this article are those of the authors and not necessarily those of the Australian Treasury.

2 The sustainable level of extraction may be thought of as the level of extraction that avoids damaging the environment in ways that would constrain future economic, environmental and amenity uses. In Australia, national water quality guidelines established by the Australian and New Zealand Environment and Conservation Council are supplemented by state and regional guidelines established to meet specific water quality management objectives (NLWRA 2002).

3 Less efficient water use practices can involve significant amounts of water seeping or running back into rivers so that it can be ‘re-used’ downstream.

4 Options such as recycling and desalination are feasible in some instances but are typically costly and can have adverse environmental impacts.

5 However the riparian doctrine relied on downstream users challenging upstream use and if the upstream use was not challenged within a certain period of time, it acquired the status of a ‘prescriptive’ right. As a result, many people took large amounts of river water, because their use was not disputed in time.

6 Per capita urban water consumption has fallen over the past 20 years. For example, Sydney has been able to accommodate an additional 700,000 inhabitants without increasing total water use (WSAA 2005). Urban industrial water use is not large and is falling as industries become more water efficient. (NLWRA 2002).

7 This economic cost includes the welfare cost of reduced access to water.

8 It is unclear whether this estimate has been made on the same basis as the definition of economic cost outlined previously, however it is indicative of the scale of the costs imposed by water restrictions.

9 Water productivity can be measured either for an individual user, for a group of users, or for the economy as a whole. When dealing with multiple users, water productivity is also referred to as the average product of water. The related concept of the marginal product of water is discussed later in this paper.

10 The marginal product of water is how much additional economic production an industry would generate (measured in terms of its value added) were it to receive an additional unit of water, but holding all other inputs constant. In comparing the marginal product, transport, treatment and transactions costs should be taken into account. These costs can be significant and sometimes prohibitive, as in practice water used in one area may not be able to be transported or purified to meet the needs of another area or industry.

11 Douglas, Dwyer and Peterson
(2004) provide a more detailed discussion of this distinction between the marginal and the average product of water.

12 In some cases, these data may underestimate the GVA per megalitre of water used due to such factors as the planting of a second crop on flood-irrigated land.

13 See http://www.statewater.com.au/indexes/index.asp for more information.

14 For example, the majority of water entitlements in New South Wales are ‘general security’, while Victorian entitlements are largely ‘high security’. Water availability to general security licence holders is announced as a proportion of entitlement, commonly referred to as an ‘allocation’. The announced allocation depends upon the resources currently available in storage and those resources expected to be available during the season. An initial allocation made at the start of the season is updated continuously to reflect rainfall in the catchment (Crean, Jayasuriya and Jones, 2001). High-security water entitlements generally have all of their allocated water delivered each year and are not subject to announced allocations.