s u m m a r yGrowing water extractions combined with emerging demands for environment protection increase competition for scarce water resources worldwide, especially in arid and semiarid regions. In those regions, climate change is projected to exacerbate water scarcity and increase the recurrence and intensity of droughts. These circumstances call for methodologies that can support the design of sustainable water management. This paper presents a hydro-economic model that links a reduced form hydrological component, with economic and environmental components. The model is applied to an arid and semiarid basin in Southeastern Spain to analyze the effects of droughts and to assess alternative adaptation policies. Results indicate that drought events have large impacts on social welfare, with the main adjustments sustained by irrigation and the environment. The water market policy seems to be a suitable option to overcome the negative economic effects of droughts, although the environmental effects may weaken its advantages for society. The environmental water market policy, where water is acquired for the environment, is an appealing policy to reap the private benefits of markets while protecting ecosystems. The current water management approach in Spain, based on stakeholders' cooperation, achieves almost the same economic outcomes and better environmental outcomes compared to a pure water market. These findings call for a reconsideration of the current management in arid and semiarid basins around the world. The paper illustrates the potential of hydro-economic modeling for integrating the multiple dimensions of water resources, becoming a valuable tool in the advancement of sustainable water management policies.

Gisser and Sánchez (1980a) state the conditions under which welfare gains from policy intervention are negligible in aquifer management, when compared with non-regulation or “free market” outcomes. This is the so-called Gisser–Sánchez effect (GSE), which has been supported by the ensuing literature during recent decades. The GSE requires a number of assumptions, among which is the disregard for aquatic ecosystems linked and dependent on aquifer systems. The depletion of aquifer systems in arid and semiarid regions worldwide is causing acute water scarcity and quality degradation, and leading to extensive ecosystem damages. This study shows that by including environmental damages into the analytical model, results can change substantially. The analysis highlights both theoretically and empirically the importance of policies in groundwater management, as well as the potential role for stakeholders' cooperation. The empirical application deals with two large aquifers in Spain, the Western La Mancha aquifer which is grossly mismanaged, and the Eastern La Mancha aquifer, which is moving towards sustainable management. Western and Eastern La Mancha aquifers illustrate that policies and institutions are essential to avoid the current global aquifer mismanagement

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Water scarcity is a critical environmental issue worldwide, especially in arid and semiarid regions. In those regions, climate change projections suggest further reductions in freshwater supplies and increases of the recurrence, longevity and intensity of drought events. At present, one important question for policy debate is the identification of water policies that could address the mounting water scarcity problems. Suitable policies should improve economic efficiency, achieve environmental sustainability, and meet equity needs. This paper develops and applies an integrated hydro-economic model that links hydrological, economic and environmental elements to such issues. The model is used to conduct a direct comparison of water markets, water pricing and institutional cooperation, based on their economic, environmental and equity outcomes. The analysis is performed in the Jucar Basin of Spain, which is a good natural experiment for studying water scarcity and climate change policies. Results indicate that both institutional and water market policies are high performing instruments to limit the economic damage costs of droughts, achieving almost the same social benefits. However, the environmental effects of water markets are worrying. Another important finding is that water pricing is a poor policy option not only in terms of private and environmental benefits but also in terms of equity.

a b s t r a c tClimate change impacts and the growing concern on environmental water demand are further increasing competition for scarce water resources in many arid and semiarid regions worldwide. Under these circumstances, new water allocation mechanisms based on the involvement of stakeholders are needed, for an efficient and fair allocation of water and income among users. This paper develops a cooperative game theory framework in order to analyze water management policies that could address scarcity and drought in a typical arid and semiarid basin in Southeastern Spain. The results provide clear evidence that achieving cooperation reduces drought damage costs. However, cooperation may have to be regulated by public agencies, such as a basin authority, when scarcity is very high, in order to protect ecosystems and maintain economic benefits. The cooperative game theory solutions and stability indexes examined in this paper demonstrate the importance of incorporating the strategic behavior of water stakeholders in the design of acceptable and stable basin-wide drought mitigation policies.