Eduardo Araral | The promise and peril of water markets

In a landmark report, the Global Commission on the Economics of Water recently identified water markets as a fundamental solution to the world’s escalating climate-driven water crisis.

The logic is simple: When something is scarce, it becomes more valuable. By pricing water appropriately and creating markets to allocate water based on demand, we could promote more efficient use and incentivise conservation. Yet while the concept of water markets appears promising, Chile, Australia, the United States, and other countries’ experiences show that implementation can prove challenging.

Water markets have been heralded for their ability to allocate water more efficiently. When individuals or organisations are allowed to trade water rights, water is allocated to those who value it most. In Chile, one of the first countries to implement a national water market, agricultural producers can purchase water from other regions or industries that have a surplus. Owing to this flexibility, the system allows for high-value crops to flourish even during droughts.

By helping to reduce inefficient water use, Chile’s water market boosted agricultural productivity over time. Between 1985 and 2018, water-intensive agriculture in the Atacama and Coquimbo regions grew significantly as water markets allowed for more flexible allocation to high-demand areas.

The same principle has been applied in Australia’s Murray-Darling Basin, where farmers trade water rights to adapt to fluctuating water availability. As Bloomberg reports, the water trade in Australia is about AU$4 billion per year (US$2.7 billion) and has made Australia the ninth-largest food exporter in the world. The same markets can also incentivise water conservation. California’s Central Valley also allows agricultural water trading, enabling farmers to cope with periodic droughts by purchasing water from more resource-rich regions.

But Chile’s experience also highlights the pitfalls of water markets. Far from being a panacea, Chile’s water market has led to significant inequalities. Large agribusinesses have acquired substantial water rights, leaving smaller farmers and communities with little access. With wealthier players dominating the market, marginalised communities are priced out.

Such outcomes raise serious equity concerns. Water is not just an economic commodity; it is a basic human right. A system that allows the wealthiest to buy up the most water risks undermining access for those who need it most. After water rights in northern Chile’s Limarí Valley were consolidated among a few large agricultural companies, smallholders lacked sufficient water during dry years. And similar trends have been observed in California, where a small proportion of water-rights holders control a significant amount of available water, disproportionately benefiting large-scale agriculture.

Moreover, water markets can lead to environmental degradation. In Chile, diverting water to agricultural use has at times compromised the ecological health of rivers and wetlands. In Australia, over-extraction of water has led to severe environmental consequences, including the collapse of river ecosystems and the depletion of surface water and groundwater resources, threatening biodiversity.

California has encountered similar challenges. Although water trading has helped balance supply and demand in some regions, it has also exposed deep inequities. The Central Valley’s small-scale farmers struggle to compete with larger agribusinesses for water, while poorer urban communities face higher water prices. In times of drought, the market-driven system tends to favour those who can afford to pay, leaving behind the most vulnerable populations.

Speculative water hoarding is also a growing problem. In California, some entities have withheld water from the market, waiting for prices to rise, effectively turning water – a vital resource – into a financial asset. This has contributed to localised shortages and driven up prices in already water-stressed areas.

Beyond market failures, there are deeper issues of equity and justice to consider. Wealthier entities’ ability to buy up rights means that water markets are prone to monopolisation. This has been a persistent issue in Chile, where large agribusinesses and mining companies corner the market, especially in drought-prone areas.

Another challenge is that water markets often clash with traditional or prior water rights, leading to legal and social conflicts. In Chile, prior rights holders, including indigenous communities, have suffered displacement as water rights have been commodified and sold off to larger entities. Such injustices raise fundamental questions about the ethics of commodifying a resource that many communities view as a public good.

More broadly, implementation of water markets is a fraught, complex process. Transboundary water conflicts – where water sources cross regional or national borders – are a growing concern. Markets that allow one region to trade away water that is needed downstream risk sparking conflict between jurisdictions. For example, the Colorado River Basin, shared by seven US states and Mexico, has become a source of rising tensions as upstream water trading affects downstream users. Strong regulatory frameworks are essential to prevent such conflicts, but creating them requires significant political will and resources.

The promise of water markets lies in their potential to address scarcity by incentivising conservation and efficiency. But the risks they pose, especially to equity and environmental sustainability, cannot be ignored. Chile, Australia, and California provide valuable lessons on the limits of market-driven water management. Monopolisation, speculative hoarding, and environmental degradation are all significant risks when water is treated purely as a commodity.

The key is to devise a balanced approach. Water markets must be carefully regulated to ensure fair access, prevent market concentration, and protect ecosystems. Hybrid systems that combine market mechanisms with robust public oversight and community management could offer a more equitable and sustainable solution. Governments should also uphold the rights of vulnerable communities and recognise water as a public good, not just a tradable asset.

Eduardo Araral is an associate professor, former vice dean for research, and former co-director of the Institute of Water Policy at the National University of Singapore’s Lee Kuan Yew School of Public Policy. © Project Syndicate 2024www.project-syndicate.org