Designing water institutions :
            market failures and institutional response
To foster economic efficiency, says the
            author, rights to water resources must be both secure and
            flexible.  Designing institutions to deal with the physical
            peculiarities of water in a way that establishes sensible
            incentives and efficient resource use is complicated.
            Basically, establishing security in water rights requires
            protecting water users against intrusion by others. This is
            challenging, since water users are naturally interdependent.
            Security does not mean that one must be guaranteed an exact
            amount of water all the time.  Rather, it means knowing the
            probability of water availability and being certain about
            allocation procedures under changing circumstances. Economic
            efficiency in water allocation in response to short-term
            supply changes (such as droughts) requires that economically
            sensitive sectors take precedence over less sensitive or
            more adaptive sectors.  This can be accomplished through
            markets or administratively (by government agencies or
            private water user groups).  In a market scheme, rights must
            be differentiated according to the probability of receiving
            water in times of shortage.  Those with high-value uses can
            then either acquire high-probability rights permanently or
            negotiate an option to be exercised only in drought years.
            There is less agreement among experts about how to design
            institutions to provide flexible water allocation in
            response to long-run changes in demand. Certainly no one
            interested in economic efficiency would suggest either a
            complete ban on transfers or completely unrestrained
            transfers.  The difficulty is to ensure that water
            transactions allow economic development do not impose
            externalities on other water users.  Market mechanisms for
            water transfer can entail substantial transaction costs,
            which threaten to delay or stymie transfers altogether.
            Moreover, third-party and community effects continue to
            concern those involved in water transfers.  Local citizens
            and officials raise issues about the distribution of
            economic activity rather than its aggregate level (economic
            efficiency).  Perhaps these issues are negligible when the
            amount of water transferred is small in proportion to total
            supply.  But when the transfer threatens a community's
            economic base, these concerns deserve more consideration.
            Successful water institutions require a delicate interplay
            between administrative and market control. Institutions
            establish the basis for markets and can assure competitive
            conditions.  Water agencies will always be involved in
            allocation, given the economies of scale in centralized
            water management.  The challenge for water professionals is
            to structure institutions so that they foster sound economic development.