Opinion: real shortcomings exist on the very basics that go to the operation of a market for water

By Mark Pearson

Sunday August 23, 2020

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It’s been a truism of Australian policy and politics for the last 40 years that markets know best.

The truth, however, is that sometimes they don’t.

The truth is that markets sometimes fail. Because economic power is highly concentrated. Because information is not freely available and because buyers or sellers are ill-informed. Because the activities of private agents impose additional economic, social or environmental costs on society, which are simply ignored by the calculus of the market.

Just recently, the Australian Competition and Consumer Commission reminded us in stark terms of what happens when we fail to regulate markets properly. Their analysis of water trading and the deficiencies of the system of trading in the Murray–Darling Basin makes for uncomfortable national reading.

Now, the basin is an important national asset. And it has attracted billions of taxpayer dollars.

The gross value of farm production was around $24 billion in 2018–2019. More than 3 million people rely on it or drinking water and social activities. Forty Indigenous nations call the basin their country. It is a growing tourist destination and an essential environmental asset.

Basin water markets alone are worth $1.5 billion per year. In Australia, which, as an agricultural producer, is orientated toward exports, trading in water benefits each of water users, basin communities and the economy. Markets enable irrigators to manage water, and their farms, more efficiently.

The policy goal for a nation like Australia should be the operation of an efficient water market. The alternative — horrible to contemplate — is allocation by government, soviet and east-European in its design and operation, with corruption hard-baked into the system.

[Editor’s Note: Below is Alexei Navalny’s organisation’s documentary (English version) on the corruption of Russia’s natural resources markets.]

What has been revealed is that the system is not perfect. The ACCC has identified that the regulatory framework is both complex and fragmented. Governance had failed and no coherent system exists to monitor and regulate a trade in water or to enforce compliance with trading rules.

There is a pattern here.

Just recently, an independent review reported on the operation of the Environment Protection and Biodiversity Conservation Act 1999. As with the ACCC report and the regulation of water market, this EPBC inquiry identified that the existing regulatory regime has not realised desired societal goals. As with water, market participants and interested parties do not have confidence that the system for protecting the environment and conserving biodiversity is operating efficiently and well.

Both the committee of inquiry and the ACCC observed that problems arise when clear objectives are lacking or where legislative or regulatory objectives conflict. The policy overlay for the Basin requires economic, social and environmental considerations to be accounted for. As with the ECBP Act, conflicting objectives that cannot be reconciled in practice make for bad legislation — and reduce the likelihood that a positive policy outcome will be realise.

The water trading rules are a complex set of economic measures that should create efficient markets and push water to its best use. A market is an economic instrument that realises economic objectives. Social and environmental objectives should be separately enunciated and delivered using different instruments.

Accordingly, market rules too must be clear and market participants must have incentives to stick to them. Market participants need timely and complete information on trades. They must have the information they need about policies across the Basin and about the technical information that is necessary for them to operate with confidence in water trading markets.

Failure to provide consistent and timely information and to ensure transparency in market trading leads to a lack of trust, and results in decisions that are less than optimal, which therefore undermines the benefits that markets confer.

Even if we assume away poor or dubious conduct, a lack of transparency and appropriate regulatory oversight will lead to rumour and hearsay as the default position for many participants. Insiders will have the running and the devil will take the hindmost.

Years ago, as a public servant, I took a call from a very worried farmer. It was a night before Christmas, and his Christmas was to be ruined because he feared that traders and brokers in water were not acting with integrity or with his interests in mind. And if the market wasn’t right, then Christmas wouldn’t be right.

This fear of market failure cannot be overcome merely by calming words. If a system of compliance and enforcement exists, how can markets be overseen? How can conduct be assessed? How is evidence collected and how is it establish that the conduct in the market is indeed detrimental? And what does a farmer have to point to identify a breach of conduct that undermines the fairness and efficiency of the market for water?

The ACCC points out that real shortcomings exist on the very basics that go to the operation of a market for water. Communications on crucial operational aspects of the trading framework are inadequate. States collect different information and operate different systems to keep records. The regulatory oversight of market intermediaries is wanting.

These weaknesses put the entire trading framework at risk.

When it comes to a trade in water, a complex and fragmented system of regulations and rules, a patchwork quilt of state and non-state operators and a lack of rigorous enforcement impose economic costs. These costs are borne by operators themselves and, ultimately, by Australian society. We are all made poorer.

The ACCC provides evidence for the claim that water trading helps the Basin economy and individual farmers. However, a lack of consistency and failure to ensure the market participants conduct themselves properly makes it difficult to convince Basin communities that water trading is beneficial. Suspicions about the operations of the status quo make it difficult to convince bruised and sceptical communities that additional changes will result in additional benefits.

So, the solution is straightforward even if its implementation is not.

  • Clarify the objectives entailed in relevant legislation to avoid confusion between social, economic and environmental goals.
  • Don’t load markets up with environmental and social work they cannot do.
  • Make sure that markets are kept honest by establishing a regulator that can efficiently oversee, monitor and enforce market rules.
  • Address the weaknesses in the operational and policy framework by providing a regulator with a comprehensive and well-developed set of rules to monitor and enforce.

Finally, don’t think that problems will disappear if they are ignored. Markets know best  until they don’t.

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