In June 2004 the Council of Australian Governments approved the Intergovernmental Agreement on Addressing Water Overallocation and Achieving Environmental Objectives in the Murray-Darling Basin (‘IGMDB’). The IGMDB set out arrangements for a ‘Living Murray’ that includes a budget of $500 million to return 500 billion litres of water per year to the Murray River by 2009. Unfortunately, two years later and only 11 billion litres have been returned as environmental flows as a result of the initiative. In response, the Australian Government in April 2006 proposed a new scheme to purchase water entitlements from farmers who undertake water-savings measures. We examine this proposal in relation to the general economic principles for the allocation of scarce water. We contend that the latest initiative, although helpful, suffers from two fundamental problems in terms of water pricing. First, the current market price for water entitlements does not include the value of water ‘in situ’, or the benefits it generates separate from its value in consumption. Second, the constraint imposed that water users undertake infrastructure investments when selling their entitlements unnecessarily raises the cost of returning water to the Murray River. We conclude that the latest scheme to achieve the laudable goals of the ‘Living Murray’ is not cost effective and that the ratio of litres of water returned to dollars spent could be much higher if the pricing policies were changed.
