History, Statics and Options: Transaction Costs in Institutional Change for Water Resources

Institutions for use of natural resources, including water resources, typically encompass assignments of property rights to various levels of government, private entities and commonproperty organisations. Institutional reform often involves a change in these property rights, such as devolution of property rights from governments to private resource users. In institutional economics it is generally accepted that institutional change occurs to reduce transaction costs incurred in economic exchanges and regulatory actions. In many situations, including reform of institutions for use of water resources, there are two additional parameters that affect, or should affect, decisions for institutional change: (i) constraints arising from institutional history; and (ii) option values associated with some institutional structures under conditions of uncertainty about the future. In this paper, a transaction-cost framework is used to incorporate these parameters into decision-making for institutional change. Institutional reform for water use in the Murray-Darling Basin is used as an illustrative example.