Legal Change and Water Market Transaction Costs in Colorado

Water markets are commonly described as failing to achieve efficient water management because of transaction cost barriers to trade. In the western United States, two sources of legal conflict frequently drive transaction costs: (1) negative externalities of trading and (2) uncertain property rights. Conflicts arise because water law applies a no‐injury rule that prevents water transfers from modifying water available to third‐party water rights and defines water rights by historical water use, among other reasons. Existing literature suggests many legal changes to reduce transaction costs, but no studies in the western United States quantify transaction costs under proposed future changes. Here we developed statistical models of transaction costs for water transfer proponents under four specific legal changes in the state of Colorado. Two legal changes would modify the no‐injury rule, and two aim to clarify property rights. Colorado hosts active markets and has recently experienced debate over such legal changes. By surveying 100 legal and hydrologic experts, we elicited transaction cost estimates and rankings of which legal changes were most likely to increase third‐party injury. The legal changes that aim to clarify property rights had significantly lower likelihoods of increasing injury. One of these legal changes, which would not limit transferable water to historical use in certain circumstances, also had the greatest reductions in proponents' transaction costs. Meanwhile, the legal changes that directly modify the no‐injury rule project substantial transaction cost savings but much higher likelihoods of increased injury. The results demonstrate trade‐offs between reducing transaction costs and increasing third‐party effects.