Price discovery and distribution of water rights linking upstream tree plantations to downstream water markets: experimental results

This paper reports controlled experiments on markets linking downstream water entitlement holders with upstream landholders wishing to establish large tree plantations. The present study tackles the question of whether it matters who owns the initial water rights. Coase's (1960) theorem suggests initial endowments will not affect final equilibrium outcomes, in terms of water prices and water rights held by the various parties. That theorem is tested through experiments with human subjects who blindly represent different groups of water users. These are land owners in upstream water supply sub-catchments and downstream urban, irrigation and 'stock & domestic' water users, each with pre-specified marginal values of water. These values and equilibrium results calculated in an earlier modelling study provide the theoretical base for evaluating the new results. In the experiment the initial endowments of water rights were shifted between the up and downstream participants. Strong 'endowment effects' were observed; participants who held the greatest initial endowments often traded away fewer units than predicted by the theoretical model and captured greater shares of the gains of trade. Including new tree plantations in the market for permanent water entitlements can engender positive changes in economic surpluses in all sectors, with greater levels of social equity and protection of downstream wetland assets. This is in sharp contrast with reductions in river volumes reaching downstream parties and environmental assets in the absence of regulations requiring purchase of entitlements to cover extra water use by new plantations.