The Murray-Darling Basin Plan (Basin Plan) is tasked with improving welfare by internalizing the negative externalities derived from the past 130 years of policy development which has over allocated water resources to irrigators in Australia’s Murray-Darling Basin (MDB). As water scarcity increases these welfare losses are compounded. For example, during the Millennium Drought water could not be delivered to urban communities, critical environmental flow was not provided, and the typically elastic private demand for water transformed into an inelastic demand function exposing capital investment to climatic risk.
The Basin Plan utilizes the common property concept to internalize externalities by reducing the quantity of the privately held (irrigators) surface rights by 3,200 gigalitres (GL) and transferring these rights to an environmental steward. By restoring environmental flows, externalities are internalized as the environment gets a share, and the ‘quality’ of the water resources improves thus increasing economic welfare. To facilitate this transfer, an adjustment package has been designed that provides a net increase in groundwater and allocates over $10 billion in funding, split between two programs to purchase surface water. Some $3.1 billion has been allocated to purchase 1,500GL of property rights from irrigators while $5.8 billion has been allocated to gain 1,700GL by subsidizing investments in water use efficiency programs.
Water resources in the MDB are highly variable and are characterized by floods and droughts events. This variability is expected to increase as climate change is forecast to reduce supply and increase the variability of rainfall. Consequently the long run success of the Basin Plan will be dependent on the efficiency of these alternative strategies to source surface water for the environment subject to this inherent variability and increasing uncertainty.
By representing uncertainty about water supply within alternative states of nature (drought, wet and normal), the state-contingent approach (SCA) provides the capacity to examine how irrigators adapt to both the state of nature and alternative policy settings by changing inputs, production systems and transition towards opportunistically irrigating in favorable states of nature. By being able to model output and decision maker uncertainty separately, the SCA approach then overcomes the limitations of other decision making approaches. By setting up the Basin Plan as an optimization question, the net change in national welfare from irrigation can be examined against the assurance that the Basin Plan objectives are achieved (i.e. policy constraints of minimum flow targets and quality improvements). This provides the capacity to illustrate how alternative climate scenarios could alter the possibility of meeting the water reform objectives listed in the Basin Plan.
The analysis reveals that: the increased groundwater access creates inequitable wealth for irrigators and shifts climate risk towards the environment; that the optimal bundle of property rights the environmental steward needs to purchase changes by spatial location and property right description in response to the climate scenarios; that irrigators could be locked in unsustainable levels of debt by investing in water-use efficiency technology; and the current design of the Basin Plan may not deliver lasting welfare benefits.