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Water and Australia’s future economicgrowth
Rowan Roberts, Nicole Mitchell and Justin Douglas
1
 
Water is critical not only to life, but also to economic growth and environmental outcomes. Thisarticle examines how water in Australia is currently allocated and used, and explores some of the consequences of current water management arrangements. Concluding that the currentallocation of water gives rise to both technical and allocative inefficiencies, the article examinesthe 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 governmentsto address environmental concerns. Despite an ongoing water reform agenda, Australia doesnot 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 theimplementation of the NWI will require ongoing commitment from governments and other participants in the water market.
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, Maryanne Mrakovcic and Malcolm Thompson. The views in thisarticle are those of the authors and not necessarily those of the Australian Treasury.
 
Water and Australia’s future economic growth54
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 inAustralia. All of Australia’s major cities and most of its towns are located where watercan be extracted for human consumption, as well as for productive uses. Water is animportant input to almost every industry. Throughout Australia’s history, the linkbetween water availability and agricultural production has been repeatedlydemonstrated. All stages of mining production rely on water, either for exploratorydrilling, production or site rehabilitation, as well as during downstream processing.Many manufacturing processes and service industries also use water as an essentialinput.Water is clearly essential for Australia’s economic prosperity. However, Australia ischaracterised by extreme climatic variability and has the lowest average rainfall of anyinhabited continent (Bureau of Meteorology 2006). Moreover, the sustainableextraction level for many of Australia’s water resources is being approached orexceeded.
2
The consequences of this are already evident in reduced water quality,salinity and threatened biodiversity. These problems are primarily environmental, butthey can also have adverse consequences for economic production.The emergence of these problems has raised concerns that the availability of watercould place a constraint on economic growth. Some would argue that these constraintsare already emerging. There is a related concern amongst some in the community thatbecause of the scarcity of water, continued economic growth can only be achieved atthe expense of the environment.However, the finite nature of our water supplies does not have to imply reducedeconomic growth or ongoing environmental degradation. Rather, the fact that waterresources are scarce means that water, like other limited inputs to economicproduction, needs to be used efficiently and allocated to its highest value uses in orderto improve both economic and environmental outcomes. This paper starts byexamining the current allocation of water in Australia and concludes that it is unlikelythat water is currently used or allocated efficiently. This means that there is scope toimprove the allocation of water in such a way as to achieve economic growth andensure water for the environment.
2 The sustainable level of extraction may be thought of as the level of extraction that avoidsdamaging the environment in ways that would constrain future economic, environmentaland amenity uses. In Australia, national water quality guidelines established by theAustralian and New Zealand Environment and Conservation Council are supplemented bystate and regional guidelines established to meet specific water quality managementobjectives (NLWRA 2002).
 
Water and Australia’s future economic growth55
In general, markets are an efficient mechanism for ensuring that scarce resources areefficiently allocated. The next section of this paper discusses the potential benefits ofexpanding the scope and role of water markets in Australia. These include improvingthe allocation of water across industries, improving the efficiency with which it is usedwithin industries, providing incentives for investment in water infrastructure andproviding a mechanism for the provision of environmental water by governments.The Council of Australian Governments (COAG) has agreed on a number of reformsaimed at expanding the Australian water market, including the National WaterInitiative (NWI) agreed in 2004. The NWI aims to increase water trade by seeking todefine water property rights more clearly and remove institutional and regulatorybarriers to trade in water. The paper examines the effectiveness of the currentAustralian water market and outlines the progress of these reforms.The paper finishes by discussing some of the key risks and challenges that will need tobe 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 ishow much water is extracted from a water system and whether this is sustainable. Thesecond 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 itsscarcity (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 beextracted by entitlement holders exceeds the sustainable level of extraction for thatsystem. For example, it is estimated that in New South Wales, licences and waterallocations equal 120 per cent of total available water resources (Melville andBroughton 2004).Many water users have historically held licences providing for higher water extractionamounts than they have actually used. For as long as the actual amount extracted wasbelow the sustainable level of extraction, this was not a problem. However, asirrigators have increased production and used more of their licences, over-allocationhas led to overuse, in that the total volume of water physically extracted from thesystem exceeds the sustainable level of extraction. Also contributing to the emergenceof overuse is the fact that as individual irrigators adopt practices such as drip irrigation
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