Economic organization of the water sector: markets or governments?
In early civilizations, water played a relatively simple role. It was needed for transportation and drinking and it provided a fishing and hunting source. Overtime, sedentary agricultural societies evolved and water use became more important. Families began settling near springs, lakes and rivers to supply livestock and crops with water, gradually developing technologies to divert water for irrigation and domestic purposes. Babylonian, Egyptian, Hittite, Greek, Etruscan, Roman, Chinese, Mayan, Incan and other empires constructed water delivery systems such as long aqueducts to carry water to large cities.19 In fact, until the middle of the twentieth century, most societies were able to meet their growing water needs by capturing reliable and relatively inexpensive sources.
19 V. Yevjevich. 1992. Water Int., 17(4): 163-171.
When water is plentiful relative to demand, water policies, rules and laws tend to be simple and only casually enforced. As populations grow and economies expand, water sectors evolve from an "expansionary" phase to a "mature" phase.20 At a certain point during the expansionary phase, the financial and environmental costs of developing new water supplies begin to exceed the economic benefits in the least productive (marginal) uses of existing supplies. The real location of existing supplies, rather than the capture of unclaimed supplies, then becomes the least costly method to maximize benefits.
20 A. Randall. 1981. Property entitlements and pricing policies for a maturing water economy. Aust. J. Agric. Econ., 25: 195-212.
A water sector in the "mature" phase is characterized by rising marginal costs of providing water and increasing interdependencies among users. In this phase, conflicts over scarcities and external costs arise. (External costs result when one user interferes with another's supply, e.g. when an upstream user pollutes a river and raises costs for downstream users.) These conflicts eventually become so complex that elaborate management systems are needed to resolve disputes and allocate water among different users and economic sectors.
Developing effective water sector policies is troublesome for a number of reasons. First, water has unique physical properties, complex economic characteristics and important cultural features that distinguish it from all other resources.21 Second, water resource management is administratively complicated because it involves legal, environmental, technological, economic and political considerations.22 In most societies, political considerations dominate decisions on water resource use. Nonetheless, most policy options are framed and discussed in economic terms.
21 R.A. Young and R.H. Haveman. 1985. Economics of water resources: a survey. In A.V. Kneese and J.L. Sweeney, eds. Handbook of natural resources and energy economics, Vol. II. Amsterdam, Elsevier Science Publishers.
22 For example, water resource management depends on the government's ability to establish an appropriate legal, regulatory and administrative framework. In fact, markets are based on a system of enforceable private property rights. Private water markets require secure and transferable property rights, including the right to exclude other users.
This section attempts to provide a conceptual basis for understanding water policy interventions while examining the circumstances under which water policies work or fail. It comprises three parts: the first examines the relationship between the water sector and the overall economy; the second explains the social, physical and economic nature of water; the third assesses the advantages and disadvantages of broad alternative approaches to public water policy and also reviews policy issues related to the economic organization of water resource management.
Economic policy-makers tend to confront policy issues one at a time, stating policy objectives in single dimensional terms. This approach presents difficulties because a policy aimed at achieving a single objective usually has unintended and unrecognized consequences. Water managers and policy-makers need to assess the entire range of government interventions to understand fully the economic, social and environmental impacts on a given sector, region or group of people.
Improving water resource management requires recognizing how the overall water sector is linked to the national economy. Equally important is understanding how alternative economic policy instruments influence water use across different economic sectors as well as between local, regional and national levels and among households, farms and firms. For too long, many water managers have failed to recognize the connection between macroeconomic policies and their impact on, for example, technical areas such as irrigation.
Macroeconomic policies and sectoral policies that are not aimed specifically at the water sector can have a strategic impact on resource allocation and aggregate demand in the economy. A country's overall development strategy and use of macroeconomic policies - including fiscal, monetary and trade policies -directly and indirectly affect demand and investment in water-related activities. The most obvious example is government expenditures (fiscal policy) on irrigation, flood control or dams.
A less apparent example is trade and exchange rate policy aimed at promoting exports and earning more foreign exchange. For example, as a result of currency depreciation, exports of high-value, water-consuming crops may increase. If additional policy changes reduce export taxes, farmers are provided with an even greater incentive to invest in export crops as well as in the necessary irrigation (see Box 12).
National development strategies can directly influence water allocation and use in other ways. In the case of a food self-sufficiency strategy, the government may subsidize water-intensive inputs to encourage farmers to produce more rice. By providing financial incentives for rice producers, the government is influencing the demand for water and private irrigation investment through price policies.
Apart from the direct effects on water use resulting from such price policies, the increased demand for irrigation water also has intersectoral, intrasectoral, distributional and environmental implications. The agricultural sector is provided with an economic advantage in access to water vis-à-vis the industrial sector (intersectoral); water used for rice gains an economic advantage over water used for other crops (intrasectoral); rice producers with more land and access to water gain over those with less land and water (distributional); and increased pesticide and fertilizer use are likely to affect water quality (environmental).
Sectoral policies affect water use and allocation in non-agricultural sectors in a variety of ways. For example, in the western United States, 70 to 80 percent of the region's water yield results from snowmelt from the high-elevation forests, many of which are under public jurisdiction. Water yields are significantly affected by timber harvest policies on these lands. Rangeland management policies on lower elevations also alter vegetation conditions and thus affect the rate of evapotranspiration, in turn affecting streamflow and groundwater recharge.23 In such cases, it is important for downstream city water managers to recognize, understand and become involved in the decisions of other sectors such as livestock and forestry.
23 B. Saliba, D. Bush, W. Martin and T. Brown. 1987. Do water market prices appropriately measure water values? Nat. Resour. J., 27 (summer).
After struggling throughout the 1980s, the Syrian economy has performed well over the past few years. The end of a two-year drought allowed agriculture and agro-industries to recover in 1991. During the drought, the government was forced to import large quantities of wheat and barley, thereby draining foreign currency reserves. In addition, the lower water levels meant a reduction in hydropower generation, increasing the need for thermal power and, in turn, lowering crude oil exports.
Two of the Syrian Arab Republic's major national development objectives are: achieving food self-sufficiency to reduce dependency on imports; and expanding agricultural exports to earn more foreign exchange. To support these objectives, the government has invested 60 to 70 percent of the entire agricultural budget in irrigation over the past ten years.
Several factors explain this special attention for irrigation development. The irrigated area comprises only 15 percent of the cultivated land yet produces over 50 percent of the total value of agricultural production. A large part of wheat production as well as all major industrial crops, including cotton, tobacco and sugar beet, are produced on irrigated farms. Production on the remaining rain-fed area, representing 85 percent of the total area, varies greatly from year to year. At present, agriculture accounts for about 85 percent of the country's water consumption, but competition is increasing. During the 1980s, industrial water demand increased by nearly 900 percent. Current projections suggest that water requirements will be two to three times greater by 2010.
The government's effort to promote food self-sufficiency has produced a second generation of water-related problems. To encourage growth in agricultural production and enhance rural incomes, interest rates, seeds, fertilizers, pesticides, transport and energy prices are subsidized. The government also establishes purchase prices and buys industrial crops, major cereals and feedgrains; e.g. the 1992 domestic wheat price was almost twice the international price.
These policies are contributing to the proliferation of wells in the Syrian Arab Republic. Digging wells to pump groundwater accounts for 80 percent of the newly irrigated land since 1987. With irrigation, farmers obtain higher yields, more stable production and greater profit. Since water is free, the only investment expense required is the well and the pumping gear - a one-time fixed cost. Farmers obtain subsidized credit to purchase subsidized fuel for operating imported pumps purchased with overvalued currency (an implicit subsidy). With these economic opportunities, most farmers want to dig wells or pump surface water.
Other current economic pressures are also influencing farmers' decisions to dig wells and expand irrigation. For example, as incomes in urban areas increase, consumers are demanding more fruit and vegetables. At the same time, recent changes in trade and exchange rate policies are making Syrian agricultural products more competitive in regional markets. Farmers who inititally planned only on supplementary irrigation for winter wheat are finding summer vegetables and irrigated fruit production increasingly profitable.
24 D.W. Bromley, D.C. Taylor and D.E. Parker. 1980. Water reform and economic development: institutional aspects of water management in the developing countries. Econ. Dev. Cult. Change, 28(2).
In most countries, pressure has increased not only to modify investment allocations but also to recognize and accommodate new demands for water. The direct implications for water managers include fewer capital investments in new water projects, the elimination of irrigation subsidies, increased efforts to recover its cost and more emphasis on demand management to improve the efficiency of existing supplies.
Policy-makers throughout the world treat water as more than a simple economic commodity. Because water is essential to life, they often reject competitive market allocation mechanisms. Many societies believe that water has special cultural, religious and social values. Boulding observed that "the sacredness of water as a symbol of ritual purity exempts it somewhat from the dirty rationality of the market".25 In many cultures, goals other than economic efficiency play an unusually large role in selecting water management institutions. Some religions, such as Islam, even prohibit water allocation by market forces.
25 K.E. Boulding. 1980. The implications of improved water allocation policy. In M. Duncan, ed. Western water resources: coming problems and policy alternatives. Boulder, Colorado, Westview.
The international community recognizes that access to water is a basic human right. The ICWE asserted that "...it is vital to recognize first the basic right of all human beings to have access to clean water and sanitation at an affordable price".
The connection between water and human life is most dramatic in arid regions, where crop irrigation is essential to food production. In Egypt, little food can be grown without the help of the Nile for irrigation. However, the focus on water's special status tends to obscure the fact that, in most societies, only a tiny fraction of water consumption is actually for drinking and preserving life. In fact, a large portion of urban water is used for convenience and comfort. In the arid western United States, per caput water withdrawal by households frequently exceeds 400 litres per day, about half of which is used to irrigate lawns and gardens. Most of the remainder is for flushing toilets, bathing and washing cars.
Another important influence on water resource policy is societies' partiality for technical solutions. In most countries, water management is typically relegated to the engineering domain. Indeed, most water managers are engineers, who are trained to solve technical problems. As inadequate public policies are increasingly blamed for water-related problems, a strong case is emerging for emphasizing human behaviour as an additional component of water systems.
Water has two additional features that further complicate management efforts: bulkiness and mobility. The value per unit of weight tends to be relatively low (placing water among the commodities that are termed "bulky"). Unlike petroleum, the costs of transporting and storing water are generally high relative to its economic value at the point of use. In crop irrigation, the water applied may yield additional economic values of less than $0.04 per tonne of water. Water is also difficult to identify and measure because it flows, evaporates, seeps and transpires. This evasive nature means that exclusive property rights, which are the basis of a market economy, are hard to establish and enforce.
Many water management problems are site-specific and so elude uniform policy treatment. While water consumption and quality requirements are tied to local populations and development levels, local water availability usually changes with climatic variations throughout the year and over longer cyclical swings. These supplies may be highly variable and unpredictable in time, space and quality. In regions throughout India, for instance, most rainfall is concentrated during a three-month period and there are large year-to-year variations. In addition, forecasts of significant global climate change - attributable to both natural and human causes - raise concerns about longer-term supply trends (see Box 13).
Water projects that attempt to compensate for extreme seasonal variations such as floods and droughts frequently require enormous investments. The economies of size are so large in these cases that unit costs continue to exceed the range of existing demands. This is a classical "natural monopoly" situation in which a single supplying entity is the most economically efficient organizational arrangement.
On the other hand, most economies of size for pumping groundwater are achieved at relatively small outputs and multiple suppliers can therefore operate efficiently. However, aquifers are usually hydraulically linked with rivers or streams - part of a river's volume may come from underground flows and rivers may replenish groundwater stocks. This hydraulic linkage is affected when an aquifer is heavily pumped. A lowered groundwater table may draw water from a connected stream, reducing its flow to surface water users. Box 14 describes the special policy concerns related to aquifers.
To date, research has not been able to provide clear conclusions about the prospective impacts of climate change and global warning. Among the potential impacts of climate change is its effect on the hydrological cycle and water management systems. For instance, an increase in floods and droughts will increase the frequency and severity of disasters. Relatively small changes can cause severe water resource problems, especially in semi-arid regions and humid areas where demand or pollution has led to water scarcity.
The statement adopted by the Second World Climate Conference, held in Geneva in 1990, concluded that the design of many costly structures to store and convey water, from large dams to small drainage facilities, is based on analyses of past records of climatic and hydrological parameters. Some of these structures are designed to last from 50 to 100 years or even longer. Records of past climate and hydrological conditions may no longer be a reliable guide for the future. The possible effects of climate change should be considered in the design and management of water resource systems.
Data systems and research must be strengthened to predict water resource impacts, detect hydrological changes and improve hydrological parameterization in global climate models.
Agricultural impacts could be significant but researchers are uncertain whether global agricultural potential will increase or decrease. Increases in drought risk are potentially the most serious effect of climate change on agriculture. Disease and pest patterns, raised sea levels and storm surges are additional problems. It also appears that many areas will have increased precipitation, soil moisture and water storage, thus altering patterns of agricultural ecosystems and other water uses.
Source: WMO/UNEP/FAO/ Unesco/ICSU. 1990. Second World Climate Conference. Geneva; and UNEP. 1992. The state of the environment.
Aquifer management is often complicated by the aggregate impact of the actions of many individuals. Even though each individual may have a negligible impact when taken alone, the sum total can be of major importance. One example is the rapid spread of tube well irrigation in South Asia. One tube well has little effect on the total water supply, but thousands of tube wells can quickly deplete an aquifer. Establishing effective policies to regulate these many small, scattered decision-makers is exceedingly difficult.
Water provides four types of important economic benefits: commodity benefits; waste assimilation benefits; aesthetic and recreational benefits; and fish and wildlife habitats. Individuals derive commodity benefits from water by using it for drinking, cooking and sanitation. Farms, businesses and industries obtain commodity benefits by using water in productive activities. These commodity benefits represent private good uses of water which are rivals in consumption (e.g. one person's or industry's water use precludes or prevents its use by others). Government policies and regulations that concentrate on improving market access and competition are important means for improving the productive and allocative efficiency of the commodity uses of water.
The second and increasingly important economic benefit of water is waste disposal. Water bodies have a significant, but ultimately limited, assimilative capacity, meaning that they can process, dilute and carry away wastes.
Recreation and aesthetic benefits and fish and wildlife habitats were once regarded as luxury goods outside the concern of governments. Today, these two types of benefit are gaining increased attention. In developed countries, more and more people are focusing their recreational activities around lakes, rivers and seas. In developing nations, as incomes and leisure time grow, water-based recreation is becoming increasingly popular and an adequate supply of good-quality water helps provide a basis for attracting the tourist trade. Examples are cruises on the Nile in Egypt and visits to the Iguazú Falls on the Brazil-Argentina border. Likewise, information and knowledge about how humans have an impact on ecosystems have raised concern about the fish and wildlife benefits provided by water. Fish and wildlife habitats are related to both commodity and recreational uses.
Waste assimilation and recreational and aesthetic values are closer to being public goods than private goods. Public goods are non-rivals in consumption - one person's use does not preclude use by others. For example, the enjoyment of an attractive water body does not deny similar enjoyment to others. Non-rival goods require large amounts of resources to exclude unentitled consumers from using the good. Exclusion costs are frequently very high for water services such as flood control projects and navigation systems. Goods and services that are non-rivals in consumption are normally better suited to public sector interventions, including ownership, provision and regulation.
An aquifer is a geological formation, actually or potentially containing water in its pores and voids. Aquifers consist of the porous rock or soil media (sand, gravel or rock materials) within which water is collected and through which it flows. Moisture from rain or snow that escapes evaporation collects in streams as surface water or seeps into the ground. Soil water not taken up by plants seeps downwards until it reaches the water-saturated zone. Water in aquifers is called groundwater. Groundwater deposits are economical to use for human purposes if they are close to the surface (and thereby inexpensive to pump) and are of good quality.
Aquifers vary greatly in their nature and extent. The quantity, quality and ease of extraction can be determined accurately only after extensive exploration. Underground geology varies widely and is expensive to map. Aquifers may be very thin or hundreds of metres thick; some are local in character, while others extend for hundreds of kilometres. The Ogallala-High Plains Aquifer in the central-western United States underlies more than 10 million ha over six states.
Relative to surface water, groundwater moves very slowly - in some cases only a few metres per year. While aquifers may have accumulated over thousands of years, modern pumping devices can easily exhaust them more rapidly than the natural recharge rate. It is also possible to divert surface water to recharge an existing aquifer artificially and make it available for future use.
Aquifer status reports from many parts of the world suggest that all is not well with our groundwater resources. Symptoms of management problems begin with pumping rates that exceed the natural recharge. Primary symptoms are: an exceedingly rapid exhaustion of groundwater stocks and the consequent increase in pumping costs; the intrusion of poorer-quality water into the deposit being exploited; salt water intrusion from rapid pumping near seacoasts; and mineralized deposits interspersed with better-quality water.
Subsidence of overlying lands is another adverse impact of aquifer overexploitation. As water is withdrawn, the soil and rock particles comprising the aquifer are compressed into a smaller volume and, consequently, crack the earth's surface. This results in damage to buildings, roads, railroads, etc. Another consequence of overpumping may be the interruption of flows in neighbouring wetlands and streams; deprived of their water source, they are reduced in size or may dry up altogether. Other adverse effects from overpumping result when residential or farmers' wells dry up because of the presence of larger and deeper wells.
From a broad perspective, aquifer exploitation can bring about either or both of two types of social dilemma. First, overdraft is an example of a class of resource problems, usually called "common pool" problems.1 A common pool resource can be defined by two characteristics. The first is subtractibility (meaning that a unit of resource withdrawn by one individual is not available to another individual user). The second is the high cost of excluding potential beneficiaries from exploiting the resource. Fugitive or mobile resources, such as water, petroleum or migratory fish and wildlife, are typical examples of resources with high exclusion costs.
1 R. Gardner, E. Ostrom and J.M. Walker. 1990. The nature of common pool resources. Rationality and Society, 2: 335-358.
2 Ibid; and E. Ostrom. 1990. Governing the commons: evolution of institutions for collective action. Cambridge, UK, Cambridge University Press.
The roots of the problems associated with common pools are found in the inadequate economic and institutional framework within which the resource is exploited.3 Common pool resources have been typically utilized in an "open access" framework, within which resources are used according to a rule of capture. When no one owns the resource, users have no incentive to conserve for the future and the self-interest of individual users leads them to overexploitation. The characteristics of the economic institutions governing their use is the fundamental issue in managing common pool resources.
3 R.A. Young. 1993. Aquifer overexploitation: economics and policies. Proc. 23rd Conference of the International Association of Hydrogeologists, Santa Cruz, Spain.
The second type of social dilemma associated with groundwater exploitation is the imposition of external costs or externalities. In the presence of significant externalities, the calculation of costs and benefits by exploiters does not yield a collectively optimal rate of exploitation.
Most countries rely on a mix of market policies and direct government interventions to manage water resources. Each system has its own advantages and disadvantages.
A competitive market has the potential to allocate resources (water supplies) efficiently among competing demands. Producers and consumers acting in their own self-interest reach the price at which available supplies are allocated. Private producers, guided by prospective profit, seek to buy inputs as cheaply as possible, combine them in the most efficient form and create products that have the highest value relative to cost.
Consumers' incomes, tastes and preferences influence expenditure patterns, which encourage firms to produce the commodities people are willing and able to buy. Prices are forced upwards for the commodities most desired, and producers allocate resources in the direction of the greatest potential profits. The firms producing desired goods most efficiently are rewarded by profit while the unsuccessful are eliminated, so production occurs at the least cost. However, the needs of potential consumers with limited incomes may either not be met at all or be met only partially.
While the private market has the potential to produce the maximum private-valued bundle of goods and services, the public sector also plays an important role. Public actions incorporate a broader range of social goals than the private sector. The public sector can ameliorate income inequalities, promote development in disadvantaged regions, regulate private activities that harm the environment and control other undesirable effects of a private, profit-oriented monopoly.
If water as a commodity, or the economic system in which water is used, meets the preconditions for a market system, government interventions can be minimized. In competitive markets, government's primary role is to emphasize "incentive structures" and to establish "rules". Some of the most important rules are the laws governing the establishment of property rights and the enforcement of contracts.
Market economies experience shortcomings called market failures.26 Market failures occur when incentives offered to individuals or firms encourage behaviour that does not meet efficiency criteria or, more generally, because efficiency or economic criteria fail to satisfy national social welfare objectives. In these cases, the public sector may intervene to influence water provision and allocation. Market failures affecting water resources include externalities, public goods and natural monopolies. In other cases, even efficient markets may not meet societies' equity criteria so public intervention is necessary to compensate for distributional inequity.
26 C. Wolf. 1988. Markets or governments; choosing between imperfect alternatives. Cambridge, MA, Massachusetts Institute of Technology Press.
Externalities are inherent in water sector activities. An example is the detrimental effect of saline return water flows (caused by irrigation) on downstream water users. Another example is the waterlogging of downslope lands through inefficient irrigation practices. Most irrigators do not normally consider the external costs they impose on others, so governments attempt to protect affected individuals through regulations, taxes, subsidies, fees or technical standards. For instance, irrigation practices can be regulated by setting and enforcing standards to control salinity and waterlogging.
In recent years, the "polluter pays" principle has attracted increased attention in industrialized countries (and to a lesser extent in developing countries). This principle requires producers to pay the "full" cost of their production process, including externalities such as polluting water.
Water storage projects and flood control programmes represent examples of public goods. The market does not adequately supply public goods because private entrepreneurs cannot easily exclude non-paying beneficiaries and capture a return on investment. For example, it is not possible to exclude people living along a river from the benefits of a flood protection plan on that river.
A firm that experiences decreasing costs throughout its range of production is easily able to dominate the entire market and become a natural monopoly (a common situation in the water sector). Decreasing costs imply increasing returns; thus, the first firm to begin production can always underprice new entrants. Urban water supply systems, hydropower plants and canal irrigation projects are subject to this type of market failure. Unregulated monopolies can restrain production and charge excessive prices; they also have little incentive to innovate. A water supplier acting as a natural monopoly has the power to impose exorbitant costs - even economic ruin - on its customers.
Public regulation or public ownership can mitigate the undesirable effects of a private, profit-oriented monopoly. When increasing returns exist, the lowest-cost production is that of a single producer. Society is likely to benefit by regulating or owning the monopoly rather than by encouraging competitive suppliers. More than one competitive supplier would present much higher distribution costs.
While free competition is viewed as the most efficient system for allocating resources, potential market imperfections can accentuate income disparities. Societies' public welfare goals often incorporate a broad range of social objectives. Primary among these is ameliorating income inequalities between members of the society and sometimes among political subdivisions or regions. In these situations, the government may direct investment and subsidies towards specific regions or groups. Water projects provide important investment strategies both for human welfare (drinking-water and food supplies) and for infrastructure to support economic development.
· "Products" are hard to define. The outputs of non-market activities are difficult to define in practice and difficult to measure independently of the inputs that produced them. Flood control or amenity benefits of water storage reservoirs are examples of water system outputs that are hard to measure.
27 R. Wade. 1982. The system of administrative and political corruption: land irrigation in south India. J. Dev. Stud., 18: 287-299.
· Spillovers from public action. Public sector projects can also be a major source of externalities. Salinity and waterlogging of downslope lands can occur just as easily from inappropriately managed public irrigation projects as from private irrigators.
· Inequitable distribution of power. Public sector responsibilities, however noble their intent, may not be scrupulously or competently exercised. Yet the monopoly control of water supplies by public agencies provides certain groups or individuals with so much power over the economic welfare of water users that procedures to protect those of limited influence should be of prime importance.
For many years, the economic systems in a number of developing countries discriminated against agriculture through policies such as high levels of protection for domestic manufacturing sectors, overvalued exchange rates and taxes on agricultural exports. Most developing countries today are at some stage of structural reform, attempting to adjust and transform their economies towards a more liberal economic trade regime - modifying government involvement and increasing market influence.
The developing world's recent record in consolidating macroeconomic stability with solid economic growth is very mixed. Where success is evident, most of the economic transformation has taken place at the macro level and much remains to be done to effect the consequent adjustments at the micro level, at the level of water users in other words.
Even with widespread acceptance of the need for macroeconomic price policy reforms for all other sectors since the early 1980s, the dominant supporting actions for agriculture have been non-price policies. For non-agricultural sectors, the new policy mix includes minimizing state involvement in the pricing and marketing of inputs and outputs, privatization and limiting government borrowing.
Despite the irrigation sector's often being sheltered or even benefiting from the effects of these economic policy reforms, government subsidy cuts are inevitably affecting the scope and efficiency of agricultural support services. In most countries, there is a pressing need to discuss how various policy options, including both public interventions and market-oriented, private sector activities, may assist the irrigation sector in the process of economic reform.
Section III reviews the advantages and disadvantages of some of these policy measures for surface water, groundwater and water quality.