Managing Risks and Tradeoffs Using Water Markets

Abstract

Risk (and often the certainty) of adverse environmental outcomes motivates environmental regulation; other risks also affect welfare outcomes. Economic instruments are one way to reduce environmental risk while maintaining flexibility that helps manage other risks. However regulation not only mitigates risks, it also creates them. While the literature has explored some aspects of risk and economic instruments in great detail, other risks have been largely ignored. Actual and perceived risks are often a barrier to the use of economic instruments so, where they are appropriate, it would be valuable to pay more attention to mitigating risks and demonstrating that they can be mitigated. This note creates a framework for synthesising experience with economic instruments for managing risks relating to water quantity and quality and illustrates it with two New Zealand case studies for which detailed information is available. It also explores some linkages between economic instruments that are not primarily directed at water management - for example emissions trading - and water management outcomes. The surprising outcomes illustrate the importance of context for assessing impact and risk.

Keywords: Water quality, Lake Taupo, Lake Rotorua, economic instruments, risk, policy interaction

JEL Classification: D81, Q53, Q57