Water - Economics and Policy Part 3

4. WATER MARKETS AND PRIVATIZATION An economically efficient distribution of water implies that water should be allocated toward uses that generate the highest marginal values (i.e., the highest willingness to pay). In theory, transferring water from low-valued uses to higher-valued uses increases overall social welfare. At the efficient allocation, the marginal value of water would be constant across different uses, such that further transfers would not clearly result in a net increase in overall welfare.51 Table 4 provides estimates of the marginal value of water for several different uses, based on a review of existing studies from the mid-1990s in the United States. We see that the value of water can vary significantly among uses—highest for industrial and domestic uses, lowest for generating power and recreation/wildlife.52 These uses are not all mutually exclusive. For example, water could be used for recreation and then further downstream for irrigation. The table suggests that there may be some potential for reallocating water from relatively low-valued uses to higher-valued uses. However, the allocation of water in the United States and elsewhere is rarely determined by concerns about economic efficiency. Instead, water rights are allocated based on various historical and legal considerations. Table 4: Marginal Value per Acre-Foot of Water in Various Uses Water Use Navigation Recreation/Wildlife Habitat Hydropower Thermoelectric Power Irrigation Industrial Domestic Source: Frederick, et al., 1996. Average Value per AF $146 $48 $25 $34 $75 $282 $194 Median Value per AF $10 $5 $21 $29 $40 $132 $97 In the eastern United States, water rights are commonly allocated based on riparian water rights. Under this doctrine, the right to reasonable use of water is given to those who own the land adjacent to a water source. Where demands exceed the available water supply, rights may be allocated based on the amount of water frontage of each owner. Riparian water rights generally do not allow for irrigation withdrawals or the transfer of water to lands nonadjacent to bodies of water. While riparian water rights were initially applied in the western United States, by the late 1800s the water demands of agriculture and mining necessitated a different water 51 As mentioned earlier, we would need to account for differences in water quality. The marginal WTP for residential water would not be equal to the marginal WTP for irrigation water at the efficient allocation because the water quality needs of these users differ. 52 Note that a large difference between the average and median values indicates that a relatively small number of particularly large estimates shifts the average upward. 31 rights system. Prior appropriation water rights separate the right to water from land ownership. Under this system, a right to water is recognized when someone establishes a beneficial use for it, such as for irrigation or municipal use. This system is also called “first in time, first in right” because rights are assigned on the basis of when a beneficial use first occurs. Say, for example, that a farmer begins to withdraw 1,000 AF of water per year from a river. Then suppose several years later a factory wishes to withdraw 5,000 AF per year from the same river. The farmer would be recognized as the “senior appropriator” and the factory (the “junior appropriator”) would only have access to water after the farmer takes 1,000 AF. Anyone else who starts to withdraw water after the factory has established its right could still establish a prior appropriation right, but only after both the farmer and factory have taken their full allotment. In the case of a drought, if only 3,000 AF were available from the river, the farmer could get his or her full allocation of 1,000 AF, the factory would get the remaining 2,000 AF, and any other more-junior water users would get nothing. Obviously, the doctrine of prior appropriation doesn’t allocate water in an economically efficient manner. In fact, it tends to discourage conservation because if senior water right holders start using less than their full allocation, over time the amount of water associated with their rights could be legally reduced. Also, prior appropriation rights tend to make no allowance for ecological needs. Thus in the case of water shortages, ecosystems may suffer significant damage. The creation of water markets has been proposed as a way to increase the economic efficiency of water allocation in the presence of prior appropriation rights. In a water market, water right holders can sell some of their water to willing buyers. One example is a farmer who sells some of his or her water to a municipality. The municipality might buy the water in a one-time purchase (referred to as a lease) or could buy the actual water rights, which would establish it as the senior appropriator for a given amount of water per year. As in any other market transaction, a water market in theory increases social welfare because both the buyers and sellers perceive that they will benefit from the transaction. But efficiency gains may need to be weighed against the impact of water markets on existing inequities. If poor people hold secure water rights, then water markets could provide an additional source of income. More likely, though, is that water could be directed away from the needs of the poor toward profitable uses by large-scale farmers, corporations, or other interests. For example, water markets were established in Chile in the early 1980s but led to higher water prices as a result of speculation and the monopolization of water rights. In 2005 the Chilean water market laws were revised to limit the potential for speculation and monopolization. A water market does not necessarily require the direct transportation of water. An upstream water right holder could easily sell her rights to a downstream user. The upstream right holder would simply withdraw less water, allowing the downstream user to withdraw more. The sale of water rights from a downstream user to an upstream user could also be conducted similarly. But in some cases a water sale may require water to be transported through canals or pipes. 32 A fairly complex system for water transfers has already been established in the western United States. The California State Water Project and the Central Arizona Water Project are examples of engineering projects that transport water hundreds of miles to its final users. The conditions necessary for a successful water market to form have been identified as: • • • • • • Water rights must be clearly defined. Water demand must exceed water supply. There must be some water users or potential users who are unable to obtain all water they seek at prevailing prices. Water supplies must be transferable to where water is desired for purchase and available when it is needed. Also, transaction costs must be relatively low. Water buyers must be confident that purchase contracts will be honored, with appropriate regulation and oversight. A system must be in place to resolve conflicts. This could involve both legal proceedings and less-formal resolution options. The cultural and social context must be considered. Some regions may resist water markets if most people believe water is not a salable commodity.53 Water markets are in place in several countries, including Australia, Chile, South Africa, the United Kingdom, and the United States. An analysis of water markets in the United States identified about 1,400 water sales between 1990 and 2003.54 Most of the water volume transferred involved short-term leases rather than outright purchases of water rights. Municipalities were the most common purchaser of water (normally from irrigators), but transfers between irrigators were also common. About 17 percent of the water purchased was for environmental purposes, including purchases by municipalities and environmental organizations. The potential for water market transfers to meet environmental objectives, such as maintaining sufficient in-stream flows for wildlife habitat, is receiving increased attention. Some analysts see great potential for water markets to improve the environment: Overcoming [barriers to water market trades] is an increasingly important challenge as populations and western economies continue to grow. With this growth comes increasing demands for environmental and recreational amenities. … Removing barriers to trade will reduce transaction costs, promote more efficient water allocation among offstream and instream uses, create incentives for improved water use, and improve environmental quality.55 Even where environmental values exceed the values of other water uses, the proper institutions must exist to obtain the necessary funding. Voluntary contributions to environmental organizations can raise some funds to purchase water rights, but the presence of free riders means that environmental water purchases will be undersupplied to society. Also, water markets can harm as well as help the environment. Water transfers 53 Conditions adapted from Simpson and Ringskog, 1997. Brown, 2006. 55 Scarborough, 2010, p. 33. 54 33 can degrade water quality and excessively deplete aquifers.56 And as in any market, negative externalities may require government intervention to internalize the externalities. Water Privatization A related issue is whether water should be supplied as a public good by government agencies or as a commodity by private companies57. Water privatization has been promoted by international organizations such as the World Bank and International Monetary Fund on the grounds that private companies can provide more efficient and reliable service than public entities, particularly in developing countries. In theory, if a private company can provide water at a lower cost, then these cost savings can be passed on to customers, and perhaps more people can obtain access to water. But without appropriate regulation a private company may be able to charge excessive rates or fail to address the water needs of low-income households. Water privatization has occurred, to some extent, in many countries, including Brazil, China, Colombia, France, Mexico, and the United States. The experience with water privatization has been mixed. According to the World Bank, water privatization in Manila, Philippines, has been successful in expanding water supplies to poor households: By expanding the provision of reliable and affordable services to customers, the program has benefited some 107,000 poor households since its inception in 1997. Near-to-regular access to potable/piped water supplies and increased community sanitation facilities has been achieved in low-income residential centers. Furthermore, the program established customer facilities to encourage communities to discuss and participate in the process of expanding services, and to resolve their concerns.58 However, in other cases water privatization has failed to deliver on its promises. Perhaps the most dramatic example was the experience in Bolivia (see Box 6). Water markets and privatization are clearly not a universal panacea for water problems. The tide to privatization seems to have turned at the global level: “A report by the Transnational Institute (TNI), Public Services International Research Unit and the Multinational Observatory suggests that 180 cities and communities in 35 countries, including Buenos Aires, Johannesburg, Paris, Accra, Berlin, La Paz, Maputo and Kuala Lumpur, have all “re-municipalized” their water systems in the past decade. More than 100 of the “returnees” were in the US and France, 14 in Africa and 12 in Latin America. Those in developing countries tended to be bigger cities than those in richer countries.”59 56 Chong and Sunding, 2006. As discussed previously, water resources have also been customarily considered as Common Property Resources by countless societies and communities throughout history and all over the world, who have governed this water according to institutional rules that resembled neither the State nor the market, as observed by Elinor Ostrom. 58 World Bank, 2010, page 2. 59 “Water Privatization: a worldwide failure?” The Guardian, January 30, 2015. 57 34 Leading the remunicipalization trend are countries with a long history of private water management. “It is no accident that France, the country with the longest history of water privatization and the home to the leading water multinationals, presents so many cases of remunicipalization. French local authorities and citizens have experienced firsthand the “private management model” that Veolia and Suez have exported around the world. In the past few years many French cities have decided to follow in the footsteps of Grenoble and Paris and take back control of the water system.”60 Remunicipalization can improve access and quality of water services, and also offers opportunities to build democratic governance, strengthening accountability and transparency. Although the World Bank and other international financial institutions are still promoting privatization under all its forms, water markets and privatization cannot be considered as the unique solution that solves all problems. The challenge is to ensure that markets and privatization operate in a manner to meet broader social and environmental goals, rather than simply maximize profits. For more on this debate, see Box 7. Box 6: Bolivia Water Wars In Bolivia, in the city of Cochabamba, the municipal water company SEMAPA was sold in the late 1990s to a transnational consortium controlled by U.S.-based Bechtel in exchange for debt relief for the Bolivian government, and for new World Bank loans to expand the water system. A new law allowed this consortium, Aguas del Tunari, to administer not only the water resources that were under the control of SEMAPA but also communal water systems. Local farmer-irrigators feared that “even the rain” collected and distributed for centuries by their local associations would fall within Bechtel’s grasp. These concerns, along with a 50% average increase in water rates for customers, prompted the formation of a broad alliance of farmers, factory workers, rural and urban water committees, neighborhood organizations, students, and middleclass professionals in opposition to water privatization. After several weeks of civil disobedience and angry protest in the streets, popular pressure forced the Bolivian government into negotiating the abrogation of the contract with Bechtel and returning SEMAPA to public control. Sources: “The politics of water in Bolivia” http://www.thenation.com/article/politics-water-bolivia; “From water wars to water scarcity: Bolivia’s cautionary tale” https://nacla.org/blog/2013/6/5/water-wars-water-scarcitybolivia%E2%80%99s-cautionary-tale http://www.theguardian.com/global-development/2015/jan/30/water-privatisation-worldwide-failure-lagosworld-bank; Transnational Institute, 2015, p.3 60 Ibid. p.5 35 Box 7: The New Oil: Should Private Companies Control our Most Precious Natural Resource? Nearly everyone agrees that global water supplies are being used unsustainably. Can privatization lead to more sustainable practices, with market prices motivating water conservation? Privatization of water supplies has traditionally been implemented in developing countries. In the late 1990s the World Bank pushed scores of poor countries to privatize their water supplies as a condition for receiving desperately needed economic assistance. In several cases, most infamously Bolivia, private companies raised the price of water so much that poor families couldn’t afford enough to meet basic needs. But more recently emphasis has shifted to privatizing water in richer countries. “These are the countries that can afford to pay,” says water rights attorney James Olson. “They’ve got huge infrastructure needs, shrinking water reserves, and money.” The need for better water management is especially acute in China. As groundwater demands increase in Beijing, wells dug around the city must reach ever-greater depths (nearly two-thirds of a mile or more, according to a recent World Bank report) to hit fresh water. With contracts to supply water becoming more lucrative, the number of private water utilities has skyrocketed. But in order to recover investment costs, companies have dramatically raised the price of water. “It’s more than most families can afford to pay,” says Ge Yun, an economist with the Xinjiang Conservation Fund. “So as more water goes private, fewer people have access to it.” The World Bank continues to promote privatization, noting that higher water prices are necessary to induce conservation. Public utilities rarely charge enough to reflect the true economic and social costs of water, which privatization advocates argue is the root cause of unsustainable water use. From the perspective of social welfare, even market prices are too low if they fail to account for externalities. But economic efficiency may conflict with the goal of equity. Privatization may work best when combined with policies ensuring that poorest can afford enough water to meet their basic needs, as in the South African system that provides a basic supply of water for free, with increasing prices for larger quantities. Source: Interlandi, 2010. 36 5. THE FUTURE OF WATER As the human population increases, available freshwater per person will decrease: [According to projections], more than 2.8 billion people in 48 countries will face water stress or scarcity conditions by 2025. Of these countries, 40 are in West Asia, North Africa or sub-Saharan Africa. Over the next two decades, population increases and growing demands are projected to push all the West Asian countries into water scarcity conditions. By 2050, the number of countries facing water stress or scarcity could rise to 54, with a combined population of four billion people—about 40 percent of the projected global population of 9.4 billion.61 Water shortages will be exacerbated in some regions because of climate change. Warmer temperatures speed up the hydrological cycle. In general, already wet areas will become wetter, increasing the likelihood of flooding. But already arid areas are likely to become drier, increasing the probability of droughts.62 (See Box 8.) Box 8: Hundred-Year Forecast: Drought Drought conditions were widespread in the United States in 2012, and the average temperature in the country set a new record high. A severe drought hit the South Central U.S. states in 2011 and an extreme five-year drought took place in Western states in the early 2000s. Until recently many scientists thought of climate change as a threat to “the future.” But with drought conditions occurring with increasing frequency, it is becoming increasingly clear that we may already be living with the “new normal” of climate change. Still, the worst may be yet to come. Assuming no significant policy changes, projections by the Intergovernmental Panel on Climate Change indicate that average rainfall in the American West will be less than the average during the 2000-2004 drought. Climate change models “suggest that what we consider today to be an episode of severe drought might even be classified as a period of abnormal wetness by the end of the century and that a coming mega-drought—a prolonged, multi-decade period of significantly below-average precipitation—is possible and likely in the American West.” Emergency measures instituted during recent droughts may need to be made permanent. The extent of irrigated agriculture may need to be reduced. While there may still be time to avoid the risk of mega-droughts, “there can be little doubt that what was once thought to be a future threat is suddenly, catastrophically upon us.” Source: Schwalm et al., 2012. 61 62 UNEP, 2008. Dore, 2005. 37 Projections for 2050 Global water demand is projected to increase by 55 percent between 2000 and 2050, as shown in Figure 15. All the demand growth is expected to occur in countries that are not members of the Organization for Economic Cooperation and Development (OECD), mainly China and India. While the global demand for irrigation water is actually projected to decline in the coming decades due to increased irrigation efficiency, significant growth is expected for manufacturing, domestic, and electricity needs. According to the OECD, “In the absence of major policy changes and much better water management the situation will deteriorate and water availability will become increasingly uncertain.”63 Figure 15: Global Water Demand, 2000 and 2050 Source: OECD, 2012. These projections might be modified with the impacts of climate change, which is feared to exacerbate water scarcities in arid and semi-arid regions. The mega-drought currently experienced by the Western States of the U.S. might become a permanent feature of this region, which could irreversibly turn its ecosystems into parched desert lands. The combination of increasing demand and limited supplies means that water allocation and management will remain crucial issues throughout the twenty-first century. 63 OECD, 2012, p. 1. 38 SUMMARY Water systems are under pressure from steadily growing agricultural, industrial, and urban demand. Many countries currently experience permanent water stress, defined as less than 1,700 cubic meters per capita available supply. Shortages will become more serious as population grows and climate change impacts precipitation patterns and glacial runoff. Increasing supply by pumping from aquifers has led to groundwater overdraft in major water-scarce areas throughout the world. Construction of dams also increases available supply, but most major dam sites are already being exploited, and new dam construction often involves major environmental and social costs. Desalination offers the potential to tap into a virtually unlimited supply of ocean water, but it is energy intensive and expensive. Sources of water include “green”, “blue”, and “gray” water – green in natural ecosystems, blue in bodies of water such as lakes and aquifers, and gray in runoff from human use diluted sufficiently to be available for reuse. The concept of “virtual water” includes all water used in the production of a good, and can be the basis for the calculation of a “water footprint” for an individual or country. The virtual water concept can also be used to measure the amount of water embodied in traded goods, showing virtual water flows between countries. Proper water pricing can promote conservation and encourage technologies for efficient water use. Government policies, however, often subsidize water, thereby encouraging overuse. Higher prices will reduce demand, but since water demand is inelastic, relatively large price increase are necessary to induce significant conservation. Well-designed price structures, such as increasing block pricing, can also promote conservation. In theory, water markets can increase the economic efficiency of water allocation by allowing transfers from low-valued uses to higher-valued uses. Water markets can also be used to meet environmental objectives, although the results have been mixed. Privatization of water supplies has also produced mixed results, expanding affordable access in some situations while leading to dramatic price increases and reduced access in other cases. The evidence indicates that while both the private and public sectors have a role to play in meeting water challenges, regulation and institutions are needed to ensure that water is optimally managed. 39 DISCUSSION QUESTIONS 1. Suppose you were managing a public water utility facing a shortage due to drought conditions. What steps would you take in response to the drought? 2. Human demands for water can lead to an insufficient supply for maintaining natural resources such as wetlands and fish habitat. How would you balance the allocation of water between human and environmental demands? 3. Do you believe that access to safe drinking water is a fundamental human right? How should water be priced in developing countries, considering the potentially conflicting issues of affordability and conservation? GLOSSARY absolute water scarcity: when the water supplies in a given region fall below 500 cubic meters per person per year. average-cost pricing: a water pricing strategy in which price is set equal to the average cost of production (or equal to average cost plus a profit mark-up if the water utility is a forprofit entity). beneficial use: term used to refer to the use of water for productive purposes, such as irrigation or municipal supplies. economic water scarcity: situations where proper infrastructure in water distribution, water recycling and treatment, and sanitation are lacking, leading to inadequate water supply desalination: the removal of salt from ocean water to make it usable for irrigation, industrial, or municipal water supplies. hydrologic cycle: the natural purification of water through evaporation and precipitation. micro-irrigation: irrigation systems that increase the efficiency of water use by applying water in small quantities close to the plants. price elasticity of demand: the responsiveness of the quantity demanded to price, equal to the percentage change in quantity demanded divided by the percentage change in price. prior appropriation water rights: a system of water rights allocation in which rights are not based on land ownership but on established beneficial uses. regulated monopolies: monopolies that are regulated by an external entity, for example through controls on price or profits. 40 riparian water rights: a system of water rights allocation based on adjacent land ownership. tragedy of the commons: an expression used by Garrett Hardin (1968) to describe the perverse effect resulting from the pursuit of personal interest by each individual user of a common resource in the absence of regulation of the access to the resource (in quantity and quality), leading to its degradation and potential destruction. virtual water: is the volume of freshwater used to produce any product, measured at the place where the product was actually produced water consumption: water that is permanently withdrawn and consumed, so that it cannot be returned to the source. water footprint: Is defined for any consumer (individual, institution, Country) as the total volume of freshwater consumed and polluted for the production of the goods and services consumed by the consumer. It is calculated by adding the direct water use by people and their indirect water use (the total amount of all virtual water contained in all consumptions). water markets: mechanism to sell water or water rights to potential buyers. (15) water pricing: setting the price of water to influence the quantity consumed. water privatization: the management of water resources by a private for-profit entity as opposed to a public utility. water scarce: term used for countries where freshwater supplies are less than 1,000 cubic meters per person per year. water withdrawal: water taken from a surface or groundwater source (water withdrawal is distinct from water consumption, since water withdrawn may be returned to the source or to another source after use). water stressed: term used for countries where freshwater supplies are between 1,700 and 1,000 cubic meters per person per year. 41