Realising environmental demands in water markets

To achieve Pareto efficiency through market allocation, property rights over resources must be comprehensively defined and defended. This ensures that the full range of benefits and costs arising from their use are assigned and enforced. Competition between those with interests in a resource ensures that allocation is to the highest marginal net value use (Kasper 1998). The difference between the marginal net values of a resource prior to and subsequent to market place reallocations is known as the gains from trade. These gains from trade provide a powerful rationale for society to ensure the definition and defence of property rights. A complication to this logic arises when it is recognised that the definition and defence of property rights and their subsequent reallocation by trading in markets are costly activities in themselves. The existence of these so-called transaction costs limits the extent of gains from trade. Indeed if the transaction costs involved are greater than the potential gains from trade, then trade in a resource may prove unproductive for society. Put simply, in those circumstances, the costs involved in establishing and implementing trade are greater than the benefits that would result (Demsetz 1967). Such a situation can arise when a resource can be used to provide benefits that are ‘non-excludable’: that is, when the identification of beneficiaries is problematic (rights definition) and/or where beneficiaries cannot be precluded from use (rights defence).