WATER: INSTITUTIONAL FRAMEWORK AND ITS ... - Cepal

Pontificia Universidad Católica de Chile Faculty of Agriculture and Forestry Department of Agricultural Economics Program of Natural Resources Economics

WATER: INSTITUTIONAL FRAMEWORK AND ITS RELATIOSHIP WITH ECONOMIC GROWTH Guillermo Donoso Harris Oscar Melo

Santiago, Chile, May 2004

TABLE OF CONTENTS

1.

INTRODUCTION ................................................................................................................................ 3

2.

THE IMPORTANCE OF WATER FOR ECONOMIC GROWTH AND HUMAN DEVELOPMENT................................................................................................................................. 6 2.1 2.2 2.3 2.4 2.5

3.

CURRENT AND FUTURE AVAILABILITY OF WATER RESOURCES AND THE PROBLEM OF WATER SCARCITY ................................................................................................................... 14 3.1 3.2

4.

CURRENT STATUS AND FUTURE PROJECTIONS FOR THE AVAILABILITY AND USE OF WATER RESOURCES. ........................................................................................... 14 CAUSES OF GLOBAL WATER SHORTAGE: A PROBLEM OF PHYSICAL AVAILABILITY OR AN ECONOMIC PROBLEM? ................................................................ 16

RELATIONSHIP BETWEEN THE USE OF WATER AND ECONOMIC GROWTH: THEORETICAL FOUNDATIONS AND EMPIRICAL EVIDENCE. .................................................. 20 4.1

4.2 4.4 5.

WATER FOR DIRECT HUMAN CONSUMPTION................................................................... 6 WATER FOR USE IN AGRICULTURE. .................................................................................. 8 WATER FOR INDUSTRIAL USE........................................................................................... 10 WATER IN POWER GENERATION. ..................................................................................... 11 WATER FOR ENVIRONMENTAL AND RECREATIONAL USE. ......................................... 12

MICROECONOMIC FOUNDATIONS OF WATER USE DECISIONS................................... 21 4.1.1 THE DECISION OF AGRICULTURAL PRODUCERS................................................ 21 4.1.2 THE USE OF WATER IN THE INDUSTRIAL SECTOR............................................. 21 4.1.3 THE VALUE OF THE TIME DEVOTED TO OBTAINING WATER. .......................... 23 WATER AS A LIMITING FACTOR OF ECONOMIC GROWTH. .......................................... 23 RELATIONSHIP BETWEEN WATER RESOURCES AND POVERTY: THE WATER POVERTY INDEX. ................................................................................................................. 26

SOCIAL CAPITAL AND INSTITUTIONALITY IN THE PROVISION OF WATER SERVICES ....... 29

BIBLIOGRAPHY......................................................................................................................................... 39

1.

INTRODUCTION Water resources are an important factor for production worldwide.

According to

Bonnis and Steenblik (1997), many countries face water availability problems, both seasonal and non-seasonal, in addition to droughts and groundwater depletion. Furthermore, water in arid zones is so scarce that it is no longer possible to meet demand without exceeding sustainable quantity and quality usage rates. As demand from all sectors is expected to continue growing, the conflicts over water usage will worsen in the near future; this has been documented for the case of Chile by Figueroa et al, 1996 and DGA 1997, among others.

In fact, Dinar, Rosegrant and Meinzen-Dick (1997) point out that

over the past few decades, water extraction has grown at an annual rate of between 4 and 8 percent in developing countries. It is estimated that of the total 3240 km3 of water extracted in 1992, 70% was used in agriculture, 20% in industry, and 10% in drinking water (WRI, 1994, quoted by Dinar, Rosegrant and Meinzen-Dick, 1997). In OECD countries, agriculture’s relative share of total water demand is approximately 30%. That relative share rises to 50% in at least six OECD countries (Bonnis and Steenblik, 1997). The principal productive uses of water in Chile are agriculture, hydroelectric generation and drinking water provision. Specifically, there are currently 2 million irrigated hectares, an installed hydroelectric generation potential of about 3250 MW and drinking water is supplied to almost 10 million people in the principal populated centers in the country (DGA, 1997). The growing demand for water and the potential conflicts related to water usage imply that water is a scarce good, which cannot be treated as a free good if we want to achieve its socially optimum allocation. Therefore, several countries have adopted different systems to manage and regulate water in order to reach sustainable economic and social development (Bonnis and Steenblik, 1997). On the other hand, it is worth noting that the Government is also responsible for the current water usage conflicts because many of the problems related to water usage derive, in part, from government policies that (i) have disjointed the institutions in charge of water

management, (ii) permit the free use of a scarce resource, and (iii) have not encouraged significant involvement of the private sector in sustainable water management (Dinar, Rosegrant and Meinzen-Dick, 1997). In the face of this situation, the World Bank drafted a document establishing the principles for water management (The World Bank, 1993, quoted by Dinar, Rosegrant and Meinzen-Dick, 1997). These principles are: •

Managing water in a comprehensive analytical framework

•

Promoting institutional reforms and regulatory systems

•

Creating incentives for the efficient use of water

•

Promoting technologies for water conservation

•

Considering aspects that mitigate poverty

•

Promoting decentralization of water utilities

•

Encouraging the involvement of different stakeholders

•

Including environmental considerations

•

Promoting international cooperation in shared water courses.

Taking this set of principles into account, Dinar (1997) states that water management policies must be reformed, giving special attention to the management of irrigation water. There are several criteria to interpret the advantages and disadvantages of different water allocation systems. For example, water distribution between different uses and users may be analyzed from an engineering point of view, a political point of view, and even an ethical and moral point of view. In economics, maximizing social welfare is the most important criterion to analyze the advantages of alternative water allocation systems. According to this paradigm, it is worth stressing that in a setting of increasing water scarcity water must be treated as an economic good in order to give users the appropriate incentives. To reach economic efficiency, water must reflect its opportunity cost—its value in its best alternative use. The need to reflect the opportunity cost of water to reach economic efficiency derives from the fact that water is scarce and, therefore, not all water needs may be met. Thus, water must have a scarcity price that makes it possible to allocate its availability between multiple users.

A problem that aggravates the conflicts of water usage around the world is the growing deterioration of water quality because of the pollution of point and disseminated sources. Water pollution is due in part to the fact that, at the time of making a production or consumption decision, the private agent does not consider the costs it is imposing on society. This means that water pollution is a negative externality, where the private cost is lower than the social cost because the former does not include the deterioration of social welfare due to pollution1. After identifying the pollutants, most affected zones, and pollutant sources, the way of encouraging economic agents to change their behavior must be sought in order to reach the environmental target. To achieve this, the economic agents must face the total cost of their actions including unwanted external effects. As resources assigned to decontamination are limited, they must be allocated in the best way possible. From an economic point of view, the optimum pollution level is found by comparing the marginal social benefit of reducing pollution with the marginal abatement cost. To obtain that economic optimum, however, the regulating entity needs a tremendous amount of information that often cannot be obtained, making it difficult—and sometimes impossible—to determine (Baumol and Oates, 1988; Cropper and Oates, 1992). When obtaining an optimum is very costly, one can opt for a second best; in other words, an efficient although not optimum result. Based on the above, it is clear that achieving a more efficient use and management of water resources has become an essential condition to reach sustainable socio-economic development. According to Anguita and Floto (1996), “without a clear, rational water management strategy that takes into account the overall needs and limitations with regard to water resources in the different sectors of the economy, the efforts made by the public and private sectors to promote development will encounter serious limitations” (Anguita and Floto, 1996: vii).

1

These greater social costs signify water purification costs, smaller land production, smaller fishing catches, landscape deterioration, deleterious effects on human and animal health, among others.

2.

THE IMPORTANCE OF WATER FOR ECONOMIC GROWTH AND HUMAN DEVELOPMENT. Water is essential for the existence of life in the planet.

Animals, plants,

microorganisms and any other form of life need water to develop and survive. Water management significantly contributed to permit man to successfully domesticate animal and plant species. This permitted hunting and gathering societies to settle in specific places, thereby making development and civilization of the peoples possible.

Elements common to all ancient civilizations are the fact of developing near

important water courses and showing, to a greater or lesser extent, some degree of technical development in the management of water. With industrial development, the importance of water acquired a new dimension for man by becoming an important element in practically every raw-material transformation process.

Recently, the relevance of water has increased further with growing

environmental awareness that acknowledges the fundamental role of water in the sensitive global ecological balances. This section reviews the principal uses of water: direct human consumption, agricultural use, water for industrial activities, water to generate energy, and finally the environmental and recreational uses of water. The discussion is focused on establishing how in each of these functions water is a fundamental resource for economic growth and human development. 2.1

Water for direct human consumption. The most evident and important use of water for man is direct consumption. It is

estimated that human beings need between 20 and 40 liters of water per person per day to meet their minimum needs of drinking water and to prepare their food. This figure may increase by between 27 and 200 liters per day per person if water for lavatory and sanitation uses is included (Hinrichsen et al., 1998, quoted by Madulu, 2003). It is worth noting that in many homes around the world, water availability is often much lower than these minimum standards. This fact is confirmed by various studies reporting low consumption

patterns (White et al., 1972, quoted by Madulu, 2003). Domestic consumption of water must be understood in quantitative terms and qualitative terms. Although the use of water for direct consumption does not imply such a large volume in terms of water extracted compared to agriculture, it is undoubtedly the use that requires the best quality. The supply of drinking water is an essential service for human welfare and development. The increase in the life expectancy of people and the improvement in the population’s health conditions are fundamental elements and targets of economic development. On the other hand, access to health services is one of the fundamental rights of man, acknowledged by international law. Adequate sanitary conditions supported by simple personal hygiene practices permit to prevent the dissemination of infectious diseases like diarrhea and cholera, among many others, which year after year destroy millions of lives around the world. Health problems have a series of negative impacts on economic growth like the reduction of available labor, higher worker absenteeism rates, and lower productivity due to ailments. Human capital has been acknowledged as an important source of economic growth, a healthy state being one of the chief conditions for the individual to develop its maximum potential.

Empirical evidence confirms the positive effect of good health

conditions on greater economic growth (Barro and Sala-i-Martin, 1995; Bloom and Sachs, 1998; Bhargava et al., 2001, quoted by CMH, 2001). The Macroeconomics and Health Commission of the World Health Organization has identified three channels of influence of diseases on economic development (CMH, 2001). The first channel is the reduction in the number of years that an individual is expected to lead a healthy life, which it has been concluded has a greater than the income received during the additional years of life. A second channel is the effect of diseases on the sums that parents invest on their children. There are studies that reveal that higher infant mortality results in higher birth rates to compensate for that higher mortality, which prevents poor families from investing in health and education for their children. The third channel of influence is the reduction in returns on investment in businesses and infrastructure. It has been shown that although there is a possibility of hiring new workers, the costs of hiring and training new personnel imply considerable economic losses for the companies. From a macroeconomic standpoint, the smaller earnings for firms because of this reason reduce the amounts collected by the

government in the form of taxes, thereby unbalancing the government budget. Also, the prevalence of diseases caused by the lack of drinking water forces the government to spend a large amount of resources in preventing and treating those diseases, diverting funds that could have been used in other more productive areas. Besides the adverse economic effects mentioned above, drinking water shortage affects the families’ potential income. A higher incidence of diseases significantly reduces the length of an individual’s working life and the income that that individual may obtain during his/her lives. In addition, the lack of safe, reliable supply of water forces the members of the family, especially women and children to spend a large amount of time getting water from other sources. The time used in getting water can be considerable and it has an opportunity cost associated to the inability of using that time in other activities like a paid job, working at home or taking care of their offspring, among other. All this makes us think that the universal supply of drinking water should be one of the main global goals of human development. However, it is estimated that over one billion people around the world do not have access to a safe supply of drinking water, which may permit them to reach minimum levels of health and income (Rosegrant et al, 2003). 2.2

Water for use in agriculture. The availability of water is not only necessary for society and its direct consumption

needs, but it is also an important element for all kinds of productive activities. Among the current uses of water, the use in agriculture is the most important use in terms of the volume of water that is used both in developed and developing countries (Rosegrant et al, 2000). Water is considered in many places—particularly in those places where there is greater shortage—one of the most important elements, if not the most important element, in agriculture (Pasha, 2002) and its use is not limited to crop irrigation, but also it is needed for livestock raising and aquaculture. The scarcity of water in agriculture results in a significant reduction in the potential yield of the farmed area. It generates uncertainty in producers, who may feel forced to look for alternative sources of water, thereby increasing production costs. The increase in the irrigated area around the world and the permanent progress in irrigation technologies, are frequently mentioned as one of the basic causes for the

explosive increase in agricultural yields over the past decades, permitting production and price stabilization (Rosegrant et al., 2003). Donoso et al. (1999) show the relationship between the irrigated area and the evolution of agricultural produce. The study shows that countries with greater irrigated area increases have the biggest rises in agricultural domestic product. The impact of price stability is also particularly important when production takes place in large countries that have the capacity to affect international prices, as well as in predominantly rain-fed areas, which have a highly variable domestic production. On the other hand, stable prices favor investment and global economic growth and not only the growth of the agricultural sector.

Price instability of agricultural products has three

important macroeconomic effects (Timmer, 2002).

Firstly, it may affect investment

because of an increase in savings or greater uncertainty. Secondly, it may reduce the quality of investment (rate of return) because prices contain less information relevant for long-term investment. Finally, because of the spillover effect that generates additional uncertainty in the economy, instability may favor speculative investment activities against productive activities, thereby delaying economic growth. The fall in food prices—a phenomenon that has resulted in part because of the increase in the irrigated area—has particularly benefited the lower income sectors, which spend a high proportion of their income in food, and which therefore experiment a significant increase in their real salaries.

In the industrial sector, lower prices of

agricultural goods keep real costs of labor low, encouraging investment and the sector’s structural transformation (Lewis, 1954; Johnson, 1997, quoted by Timmer, 2002). There are other less evident indirect influences of water on economic development. Unlike the traditional view of agriculture as a declining economic sector, which is characteristic of more primary stages of economic development, different authors have defined a more relevant role for this productive sector in the growth process. It has been said that agriculture produces significant concatenation with multiplying effects with other sectors of the economy, it is an important source of currency, and it maintains a series of environmental and cultural values that are important to society. Finally, it is worth noting that the agricultural sector’s growth is particularly beneficial for the poorer sectors. Empirical evidence confirms the effect of agricultural growth on poverty reduction, a

significantly greater impact than the one generated by the development of other productive agents (Ravallion and Datt, 1996; Radalet and Warner. 1997, quoted by Timmer, 2002). Population growth and socio-economic development impose strong challenges to agriculture in relation to food safety. An adequate supply of food is an essential condition for economic development. Insufficient food supply may affect political and economic stability, reducing the level and efficiency of investment (Alesina and Perotti, 1993; Barro and Sala-i-Martin, 1995; Dawe (1996); Timmer, 1989, 1996, quoted by Timmer, 2002). Also, like in the case of diseases, malnutrition also affects human capital and workers’ productivity, generating another indirect mechanism that delays economic growth as a result of water shortage. The current situation in the agricultural product markets does not make it possible to project an increase in the irrigated area in line with the growth expected in the demand for food. In addition, a small proportion of the agricultural area with economic potential in the world is irrigated, although in many situations there are sufficient water resources, but there are no incentives to invest in irrigation infrastructure. On the basis of this information, meeting global food requirements will depend on increasing yields per farmed area unit, which will only be possible with a significant technological change, where greater efficiency in water management plays an essential role The above information confirms that the shortage of water for irrigation imposes severe restrictions on economic growth, particularly to those countries where agriculture constitutes a high proportion of the GDP and is the most important source of employment. 2.3

Water for industrial use. Water is an important production factor for the industrial sector. Water is used for

cooling, condensation, manufacturing operations, air conditioning, feeding boilers, cleaning raw materials and equipment, product transportation, sanitary services, among many other activities. The principal water users in the industrial sector are chemical products and their by products, paper and its by-products, oil, coal derivatives, and by-products of primary metals, which consume up to 85% or more of the total water used in mining and manufacture (Spulberg and Sabbaghi, 1998). Although the quantity of water used by the industrial sector is relatively lower compared with agricultural, the total volume of water extracted by the sector is considerable.

The importance of water in industrial processes has been underscored from an exclusively economic point of view. The weight of the cost of water in production costs is generally very low; therefore, the estimates of its use are generally subordinated to primary company decisions regarding the technological alternatives available, productive factors, product combination and operating scale, which determine the quantity of water needed in the different processes (Gibbons, 1987). It is therefore easy to understand that prices do not reflect the true economic value of water and that in the face of the low provision costs, industrial demand for water is quite inelastic. Although, in general, the industrial sector does not seem to internalize the potential problem of water scarcity, there is evidence of serious threats for industrial activity in areas with low availability. An example of this takes place in the mining sector in the north of Chile (Brown, 1996), where the large water requirements of the mining industry determine that obtaining water is a strategic priority for the mining companies. If these activities are subjected to water supply restrictions in some countries, it may have a significant effect on their economies; therefore, in those cases water shortage appears as an important restriction to economic growth. 2.4

Water in power generation. Among industrial users, the power generating sector is the subsector with the greatest

water demand. The principal source of power in the world is thermoelectric generation, a process that uses water to generate steam, the subsequent condensation of which moves the turbines. Hydroelectric generation, on the other hand, uses water flow potential in natural courses to move power generating turbines. Hydroelectric energy may be the principal source of energy in areas with appropriate hydrological conditions to generate power at a lower cost than thermoelectric energy, like in the case of Chile. Even in countries where hydroelectric generation is a secondary source of energy, it has a significant role in meeting global power demand in periods of energy crises. advantages.

According to Gibbons (1987), this generation method has a series of

First, it depends on a renewable resource, which guarantees that with a

relatively normal hydrological cycle there will be sufficient generating potential. On the other hand, one unit of water is capable of generating power in an accumulative manner, with water passing through successive turbines of different reservoirs along a river. Second, it is a clean source of energy, unlike other power generation methods based on

fossil fuels, which discharge significant emissions.

Finally, it has low maintenance

requirements, low blackout frequency, and it operates with a high degree of flexibility, all of which permit it to rapidly respond to sharp increases in demand. Donoso et al. (1999) indicate a series of important economic effects that result from the scarcity of water for power generation, particularly when hydroelectric energy is the main source of supply. In those cases, drought conditions make it necessary to look for alternative sources (thermal generation or others) to meet power demand, which generally have higher production costs.

On the other hand, extended shortage raises projected

production costs of hydroelectric plants—which are determined by the potential hydrological conditions—resulting in an increase in the rates charged to users. Finally, prolonged drought may bring about energy rationing, with high costs associated to power cuts, both for generators which must pay the so called “failure cost” and for consumers who have limited power availability. 2.5

Water for environmental and recreational use. Besides human consumption and productive uses, water fulfills a series of

environmental and recreation functions that are very important to society’s welfare. Water is essential to preserve the ecosystem and its associated biodiversity. It also permits maintaining energy balances and the normal functioning of biogeochemical cycles.

The

importance of maintaining certain minimum water flows for ecological functions is a need that has only recently been acknowledged, but that has increasingly become a priority in global water management strategies.

As a result of economic development, there is

growing ecological awareness in current society, particularly in more developed countries, and there is a legitimate demand for better environmental conditions to improve the quality of life of the people. With rapid industrial development and the associated pollution problems, water has acquired an important role as a sump of industrial and agricultural waste. The principal pollutants discharged by the industrial sector are materials that demand biochemical oxygen, heavy metals, and toxic organic matter. Agriculture has considerably contributed with the so-called “green revolution” to polluting water bodies, because of the marked increase in the use of fertilizers, pesticides and agrochemicals, in general. Therefore, waste assimilation or dilution is fundamental for the normal development of economic activity

and, as Gibbons (1987) points out, it represents a real economic value, when we consider the costs of the damage caused by pollutants to water quality. Brown (1996) has already verified the restrictive effects on production due to the lack of appropriate places to dispose of tailings in the case of the mining industry in the north of Chile. Even so, it is said that the value of water used to dilute pollutants falls with the technological improvements in the processes to treat that water (Merrit and Mar, 1969, quoted by Gibbons, 1987). Water is also important for a series of recreational uses, like sailing, swimming, fishing, and practicing water sports or simply contemplating nature.

These activities

become a final use of water, which provides its consumers with a source of leisure. They are also relevant for tourism in different places around the world. In this respect, Spulber and Sabbaghi (1988) state that over the past few decades, greater attention has been given to the use of water for recreational activities as a result of industrialization and urban development and the growing need for outdoor recreational activities. The social value given to this type of non-extractive uses of water is extremely complex because the lack of markets for this kind of environmental and recreational goods. This value, however, must recognize some important intrinsic values of water and of the natural capital in general. Water has important values of non-use, whose existence is suggested by empirical evidence and whose value in monetary terms may be estimated. Gibbons (1987) identifies three types of non-use value for water. First, the value of opting to reserve water sources for subsequent use. On the other hand, there is an existence value derived from the users’ knowledge that the water is there. Finally, there is a heritage value, derived from the conservation of water for the enjoyment of future generations. The reduction and degradation of natural water courses due to pollution, deforestation, and over-extraction of water have put many wetlands and marine ecosystems at risk. This phenomenon also affects consumers of environmental services linked to water. Therefore, an important increase in demand for water courses for environmental use is projected, which refers to the transfer of water from extractive uses to non-extractive uses. In this context, a strong competition should arise among the different uses of water. Meeting the global demands in an environment of normal economic growth will depend on investment in exploration and development of new water sources and a substantial improvement in the efficient use of water in all the sectors of the economy.

3.

CURRENT

AND

FUTURE

AVAILABILITY

OF

WATER

RESOURCES AND THE PROBLEM OF WATER SCARCITY In the Third World Water Forum held in Japan in 2003, it was concluded that the principal challenges faced by the sector are posed by the need of a safe supply of clean water for all people; good water management, including an integrated water management approach; creating capacity, including education and access to information; funding for water infrastructure; and a more active involvement by all stakeholders, including women and low-income sectors (Rosegrant et al, 2003). This section covesr the current and future availability of water resources, consumption patterns per sector and the potential threat of the scarcity of water resources worldwide. The causes for scarcity are analyzed and the real nature of the problem is discussed, comparing the views of those who hold that it is a problem of availability of physical sources, with those who state that it is a matter of lack of economic incentives to develop and efficiently use existing sources. On the basis of existing evidence, we discuss some of the steps that need to be taken to tackle the water scarcity problem in a context of steady population growth and economic development. 3.1

Current status and future projections for the availability and use of water resources. The world in general is currently facing the threat of water scarcity. The growing

demand driven by population growth and economic development generates strong competition for water between the different sectors. Meeting the demands of such sectors requires a thorough revision of current water sector planning and management, as well as of its policies and institutional framework. The information available for 1995 indicates annual extraction of 3906 km3 of water, a figure which is expected to rise to 4772 km3 in 2025 in a similar consumption and growth scenario, with 27% growth for developing countries and 11% for developed countries (Rosegrant et al. 2000). At present agriculture uses about 65% of the total, and it could reach values as high as 95% in some places like Pakistan (Pasha, 2003). Rosegrant et al. (2000) estimate a growth in demand due to potential irrigation—in other words, in absence of supply restrictions—of 12% for the 1995-2025 period. They also point out that the

proportion between current consumption and the potential demand should fall from 0.82 to 0.78 during the same period. The low prices of agricultural products determine a relatively low economic value for irrigation water and a high opportunity cost given by other alternative uses. It is thus estimated that the large water infrastructure projects will be focused on domestic and industrial use. Those sectors will therefore be the ones to show greater growth, severely restricting the growth of agricultural use of water and food production capacity. The small capacity to expand water supply for irrigation will force producers to look for alternative sources, mainly groundwater, which have a low cost and little regulation (Rosegrant et al, 2003). In that scenario, it is expected that many important aquifers will be subjected to extraction rates that exceed their natural recharge capacity. Growth of 62% has been estimated for all other water uses other than irrigation (domestic, industrial and livestock) for the 1995-2025 period, determined by a 71% increase in domestic consumption (90% of which will be accounted by developing countries) and 71% for use in livestock (Rosegrant et al, 2000). Industrial consumption will also show an accelerated growth, mainly in developing countries. Despite the lower use around the world due to changes towards more efficient water use technologies and demand policies, the high rise in industrial production will imply greater total consumption of water. The population growth and higher per capita consumption explains the considerable increase in demand of water for domestic use. Improved water distribution networks and more responsible use at homes will permit increasing the proportion of people who will have access to pipe water, particularly in developing countries where this percentage is still low. Even so, a significant number of people will continue lacking this utility, especially in the rural areas of the poorer countries. Although we did not have actual consumption figures available, the environmental and recreational uses of water are the most affected ones by the growth in the other uses. Environmental and recreational uses are the principal source from which water is transferred to the other uses. Continuous deterioration of water resources and conservation problems of important wetlands and marine ecosystems and their associated species evidence this situation. In this context it is particularly important to have water available to

assimilate residues generated by human activities. Despite current society’s pressure for a larger share of water for environmental and recreational uses, the growing demand from the other sectors does not permit us to think that under the current consumption patterns there will be an increase in those types of water volumes. 3.2

Causes of global water shortage: A problem of physical availability or an economic problem? In the current discussion about the water management policies, significant emphasis

has been placed on the nature of the problem of water scarcity. In general, there are two chief views. On one hand, there is a group who state that the main cause of water shortage is the lack of available water resources, a phenomenon that is aggravated by pollution problems and climatic change. On the other hand, there is a group that state that the problem is rather of an economic nature, caused by the lack of incentives to adequately develop and manage sufficient water resources. Although almost three fourths of the earth is made up of water, its distribution pattern is highly heterogeneous determining areas with excess water and others with severe shortage of water. Something similar occurs in terms of seasonal supply, there are areas with wet climates all year round, and others where the rainy season is extremely short or inexistent. Another characteristic of water availability is its dependence on climatic factors, which makes it highly unpredictable. All these factors determine that the use of aggregated water availability figures for countries may conceal the existence of areas with critical scarcity. Therefore, it is necessary to conduct a lower-scale analysis, preferably by basins, to detect areas that are likely to face water scarcity problems. The traditional view of water scarcity as the lack of physical availability of water, restricts the solution to the efficient allocation of water to a matter of redistribution between its different uses. Van Koppen (2003) points out that in the debates about water policies in Subsaharan Africa, the water scarcity problem is often seen as a problem where the apparent physical shortage imposes the solution of transferring water between sectors, forgetting about water development. As indicated in the previous chapter, agriculture is the sector with the greatest demand of water. Therefore, agriculture is usually blamed for water scarcity, suggesting the need of redistributing water towards more important uses (Toolbox, 2002, quoted by Van Koppen, 2003). From an economic point of view, this idea

is based on the need of transferring a determined volume of the water existing in the economy in order to balance marginal productivities in all sectors to achieve maximum global efficiency.

We must not forget, however, the importance of improving the

efficiency of water use, as well as the capacity of expanding supply by means of the exploration and development of new sources. Those who focus on insufficient water resources as the cause of scarcity, often attribute the degradation of water resources mainly—together with deforestation and industrial and agricultural pollution—to current climatic change. Madulu (2003) indicates that climatic change has been one of the most important factors in the drying up of water sources in Tanzania. Brown (1996) points out that projected average temperature rises in middle latitudes will cause a series of significant effects on Chile’s environmental conditions, particularly, on the occurrence of water resources. Global climatic change has varied impacts on the hydrological systems. Firstly, an increase in maximum flood flows of rain-fed and snow-fed rivers is expected, which may increase flood flows by 30%, putting the population and activities located in river banks at risk. Another impact is the modification in the seasonal distribution of the flows in snow-fed and rain-fed basins, determining winter and spring flows greater than historical flows and smaller summer and autumn flows. The third impact is the modification in the basins’ water yield and in crop demand due to greater evapotranspiration plus a reduction in the fraction of precipitation that gives origin to runoff and, consequently, a reduction in the water yield of the hydrographic basins and an increase in the demand from plants. However, the higher concentration of atmospheric CO2 in greenhouse gases will reduce evapotranspiration consumption. Thus, the net effects on the basins’ water yield and crop demand is uncertain. Another impact of the temperature increase caused by climatic change is the displacement of the geographic location of farming towards areas with climate conditions similar to the original farming area, with the consequential effects on the regional agricultural economies. Finally, climatic changes will cause catastrophic floods and instability in the ice zones because of the effect of the temperature increase of the air on the energy balance of the masses of ice.

Despite the foregoing, many researchers disesteem the importance of

climatic change as a cause of global water scarcity, arguing that it is the result of population growth and economic development (Vörösmarty et al. 2000, quoted by Barbier, 2002).

There are other authors, however, who point out that global water shortage is a strictly economic problem. This view is based on the fact that the amount of water resources in the world is sufficient to meet the population’s demands but that there is a lack of incentives to develop and explore new sources, to invest in water infrastructure projects and to manage water efficiently and responsibly (Molden et al., 2001, quoted in Van Koppen, 2003). In the agricultural sector, it is stated that current low water prices determine the lack of incentives to invest in irrigation infrastructure projects and in technological improvement. There is evidence that in different areas in the world there is potential to significantly increase the irrigated agricultural area. For example, although water availability per capita in Pakistan has fallen considerably, there is still sufficient water to irrigate the arable land available (Pasha, 2003). In Subsaharan Africa, Van Koppen (2003) indicates that between 1 and 50% of the arable area is currently irrigated and that it is necessary to develop water collection infrastructure to store the flows of the short rain season, which are lost to the sea or absorbed by the ground. In Chile, only 50% of the area that can be economically irrigated has permanent irrigation (Brown, 1996) and it is stated that the economic situation of the agriculture sector does not justify government investment in large irrigation projects. For the other uses, there is also evidence to conclude that the factors that determine water scarcity go beyond a simple problem of water supply. Van Koppen (2003) points out that the lack of know-how and technological support is one the important causes that prevent improving water supply to areas of Subsaharan Africa even though there are resources. In Tanzania the greatest problems for providing a water network in the country are inadequate funding for the construction and maintenance of the water systems, destruction of water sources due to deforestation, poor water quality, and poor sanitary services, social and cultural values, and lack of adequate tools (Zaba and Madulu, 1998, quoted by Madulu, 2003). In most of the communities in Tanzania, water available for domestic use depends on the effort of the communities to improving, maintaining and developing new water sources and not only on the physical abundance of water (Drangert, 1993, quoted by Madulu, 2003).

Beyond the existence of water resources, water availability for the different uses is also related to water quality aspects. Water pollution problems aggravate the problem of physical shortage by reducing the quantity of water that can be actually used. In the agricultural sector, indiscriminate use of agrochemicals has generated considerable nitrogen and phosphorus percolation problems mainly toward groundwater courses.

Given the

diffuse nature of this type of pollution, it is difficult to solve and control methods are quite ineffective (Brown, 1996). The clear-cutting of extensive forest areas to dedicate the land to agriculture has caused soil erosion and riverbed sedimentation problems. We can also mention the problem of overexploitation of wetlands, ecosystems that have the important function of regulating seasonal water balances by storing water generated in wet seasons and gradually releasing it in dry seasons. Another environmental problem related to agriculture is the increase in the salt content of soils as a result of deficient irrigation practices, which may reduce the productive potential of soils by up to 25% (Pasha, 2003). The modest sustainability of traditional agricultural practices seems to generate additional environmental problems derived from the growth of this productive sector, even though the evidence is not conclusive. Woodhouse (2003) conducted a study in semiarid zones in Africa, concluding that the change in the use of the land and water resources towards agriculture has permitted to increase yields and, although there is evidence of some initial problems, there is no concrete proof of environmental deterioration in the area to justify the vision of environmental crisis of the development agencies in Africa. An environmental sustainability study of the export sector conducted in Chile concludes that there is a potential risk of damaging environmental quality if agricultural production continues expanding, but that the actual estimates of that negative impact on the environment and the sustainability problems derived from agriculture and forestry sector growth require further studies (Figueroa et al., 1996). Industrial activity also significantly contributes to water pollution problems. Some of the most important problems are discharge of residues with a high biochemical demand of oxygen, organic waste, and solvents in the water processed in the different industrial processes. Despite these problems, it is estimated that an appropriate incentive structure for pollution control together with an adequate environmental legislation, plus the application

of the existing treatment technologies, may permit to reasonably control the impacts of industrial pollution. (Brown, 1996). Whatever the view about the nature of the water scarcity problem, it is clear that there is a problem and that it is an actual threat to water consumption needs, industrial activity, food safety, and ecosystem preservation.

4.

RELATIONSHIP BETWEEN THE USE OF WATER AND ECONOMIC GROWTH: THEORETICAL FOUNDATIONS AND EMPIRICAL EVIDENCE. Based on the diagnosis of the current situation of water and the review of future

consumption and availability projections, we conclude that the world is facing an uncertain setting with regard to its future capacity to meet global water demand.

Thus, water

availability has been identified as one of the most important environmental restrictions for development and recently as a limiting factor for population growth and food production (World Bank, 1992, quoted in Madulu, 2003). Estimates of potential increases in GDP as a result of better water management have been suggested, particularly in countries with mainly agricultural economies (Pasha, 2003). Water management has also been identified as a factor that may have a potential influence on development (Sullivan, 2002). Despite the general opinion that water shortage curbs growth and development, there is little concrete empirical evidence that permits supporting or rejecting that hypothesis. This section reviews the relationship between water and economic growth from a theoretical standpoint complemented with case studies and empirical results. This approach makes it possible to understand the factors that determine the patterns of water use by the different economic agents, and permits discussing water policies and their implications. We will start by analyzing the microeconomic grounds of water use decisions in the agricultural, industrial and domestic sectors. We will then review an economic growth model that considers water as a productive element provided by the government and subject to excess demand.

Finally, we will review the relationship between water resources

available and poverty, by describing and applying a Water Poverty Index (WPI).

4.1

Microeconomic foundations of water use decisions.

4.1.1 The decision of agricultural producers. Because of the importance of agriculture as a one of the most important users of water resources, reviewing the theoretical foundations of the decisions taken by the individual producers is fundamental. The need to use irrigation water more efficiently has been stressed as one of the most important factors to achieve greater productivity in the sector (Pasha, 2003; Rosegrant et al., 2003). We have seen how smaller availability of water together with increases in the price of water, are incentives to adopt water-saving technologies, to reduce water use within the existing practices, and to change farming patterns (Zilberman et al., 1994, quoted by Zilberman and Lipper, 1999). Efficient use of water in agriculture is not only influenced by technological factors, but also by climatic factors, edaphic factors, and water quality. These are also relevant elements that must be considered when choosing a specific technology. The decision of using water for irrigation can be divided into two stages. In the first stage, we must determine the optimum quantity of water to be used for each technology. And in the second stage we must choose the most profitable option (Zilberman and Lipper, 1999). The optimum in each technology is reached when equaling the marginal product of the water applied with the price of the water actually used (in other words, the water applied adjusted for irrigation efficiency), a price that declines with the adoption of a more efficient technology. Technological change will be implemented in those situations where the earnings generated by greater production or by irrigation cost reduction exceed the costs of implementing the new technology. The adoption of new technologies must, therefore, accelerate with the increase in the prices of the products or water, as well as in poor soils, where water actually used has a high price because of low irrigation efficiency. 4.1.2 The use of water in the industrial sector. Water is one more of the inputs of industrial processes which, in general, is characterized by accounting for a small share of total company costs. The improvement in water supply services for the industrial sector implies a reduction of water’s total economic price, in other words, the sum of the monetary provision cost plus the opportunity cost of collecting it.

The potential benefits for the companies may result from three basic

mechanisms (Davis et al., 2001): (i) the increase in the price of the product, (ii) the reduction in production costs and (iii) the increase in production levels. In the short term, the shift in demand due to the higher income of families resulting from greater company returns, and in the long term, the improvement in the quality of water because of safer and more reliable water supply may determine an increase in the price of the product. On the other hand, in the short term the company reduces the cost of obtaining, storing and treating water, it saves time in supplying itself of water and it adjusts its combination of factors to the new cost minimization levels. In the long term, the company increases the return on investment in more efficient technologies and adjusts its capital stock to the new cost minimization levels. Both phenomena permit reducing production costs. In the short term, the shift in supply makes it possible to reduce prices and increase sales. In addition, better supply makes it possible to reduce the frequency of failures in the productive process. In the long term, savings invested in expanding productive capacity increase, and greater profitability attracts new companies to the sector. Therefore, these long and short-term effects permit raising production levels. A study conducted in Uganda (Davis et al., 2001) confirmed that the owners of micro-companies in areas where there are no water supply system, perceive water supply as one of the main obstacles for company growth. This does not occur in localities where they do have water distribution systems. The surveys conducted in relation to improving the water supply system in Uganda reveal that more than half of the micro-companies consulted experimented a cost reduction, and one fifth of the companies recorded a production increase, and 13% recorded an increase in the demand for their products. This type of benefits may be substantial, particularly for small companies with funding problems, which confirms that quantitative and qualitative improvements resulting from better water supply are relevant even though water represents a small fraction of costs. Even so, estimates revealed that people were not willing to pay for connection to the private networks, a willingness that should be greater in companies that consume larger quantities of water and therefore have greater possibilities of benefiting.

Finally, the study

determined that the total economic cost of providing companies with connections to private water supply systems was substantially greater than the willingness to pay for such connections.

Therefore, the government has a fundamental role in encouraging these

investments by actively participating in infrastructure investment, generating funding alternatives and implementing systems that generate incentives for the participation of private parties. 4.1.3 The value of the time devoted to obtaining water. The provision of sanitary services to the population implies a commitment between the increasing cost of obtaining water and a series of benefits perceived by the community. In addition to the evident improvements in the population’s health conditions provided by a better water supply services, there is an important economic benefit derived from the time saved in water collection when there is no water supply network. In those situations the task of collecting water for domestic use is normally carried out by women or children, who generally must travel long distances to have access to water sources that are usually not too reliable regarding water quantity and quality. The time destined to this type of work prevents family members to carry out other important activities like a paid job, studying or domestic chores. From a theoretical point of view, the election of a specific type of source is driven by minimizing the total prices paid per water unit, including collection costs. Thus, the preferences shown for a specific source permit—through the price system—to approximate the value of the time saved in relation to the alternative of going personally to collect the water. Whittington et al. (1990) estimated the value of the time spent in collecting water in Kenya. Their results show a value of the time saved considerably higher than the current market salary for skilled workers earned by those families that bought water.

They

determined that the valuation of the time saved was directly related to the average income and inversely related with the number of women in the household, who are generally the ones in charge of carrying out that job. The authors conclude that if the high values estimated in this study are confirmed in other developing countries, pipe water distribution would be an economically attractive alternative for those places. 4.2

Water as a limiting factor of economic growth. The main empirical evidence about the relationship between water and economic

growth is found in a study conducted by Barbier (2002). The theoretical framework that supports those estimates is based on the growth model designed by Barro (1990), and Barro

and Sala-I-Martin (1992) including goods provided by the public sector subject to excess demand (Barro, 1990; Barro and Sala-I-Martin, 1992). Thus, water shortage affects economic growth through two mechanisms: firstly, the public appropriation and acquisition of a greater percentage of water by exploiting increasingly less accessible sources and, secondly, by the restriction imposed to water use by the absolute availability of water. The model indicates that growth in per capita consumption is negatively affected by the government appropriation of water; it is positively affected by the contribution of water use to the net marginal productivity of the capital; and negatively affected by water scarcity. In this context, there are two potential scenarios for a determined economy. First, a scenario where water availability is not restrictive for the economy, a situation where only the negative effect of government appropriation and the positive effect of water use to the marginal productivity of the capital, operate. In this case, the relationship between growth and the water consumption rate is strictly concave, with an optimum water usage rate that permits a maximum growth rate per capita. For water usage rates lower than the optimum, we see a rising slope in the per capita growth rate of water use and a declining slope for water user rates higher than optimum. In a second scenario, where water availability is restricted, in addition to the two effects indicated in the foregoing case, we must add the negative effect of water scarcity. In this case, the proportion of water that the government may appropriate to supply water is now determined by the relationship between the potential water supply and the aggregated product, which is limited by the maximum government appropriation rate.

From a

theoretical point of view, for a situation of scarcity in a model of this kind, the optimum situation is for the government to choose a maximum output appropriation rate to supply water to the economy. But even so, a maximum appropriation rate in itself does not guarantee the growth of an economy that is restricted by water shortage. Growth will be subject to the condition that net marginal productivity exceeds the negative effect of water scarcity.

Therefore, as Barbier (2002) indicates, for a restricted economy, water will

always be valuable from an economic point of view, in the extent that its contribution to marginal productivity will always exceed the social cost of supply, which determines that it will always be optimal to destine the highest proportion of GDP possible to extract the water available. Whether this will lead to growth or not will depend on whether the returns

in net marginal productivity compensate for the costs that the economy incurs in to supply that water. Using cross section data for 163 countries, Barbier empirically shows the assumed theoretical relationship in the form of on inverted U between water use and economic growth that may be expected for economies not subject to water restrictions. The results did not make it possible to reject the hypothetical relationship previously described for three different proved models: a quadratic model with water consumption as the only explanatory variable, another model that adds income and education variables, and a third model that further adds political, social, and economic variables. It also estimates the optimum use rate, which resulted to be substantially higher than the one actually observed for most of the countries included in the study. However, the observations only permit exactly approximating the first part of the curve, because of the low number of countries that show high water use levels.

The study also includes estimates of the water

consumption elasticity of growth, which range between 0.3 and 0.35 among the models. This evidence makes it possible to anticipate growth increases with greater water use, although not in proportion to the increase in water use. The study concludes that the current water use rates in the great majority of countries are far from restricting economic growth. On the contrary, there is a certain margin to accelerate growth by means of more efficient use of water on the basis of optimum allocation. The study concludes, however, that the increase in the use of water is a limited source of growth. The specific estimate of the optimum use rate obtained in this study will lead in the long term to a water shortage situation, determining an uncertain growth path that will depend on a higher net marginal productivity of capital than the negative effects of water scarcity, and also of the existence of water resources that the government may appropriate. Due to the difficulty of econometrically proving the theoretical result for restricted economies, we opted to evaluate the potential harmful effect of water shortage on growth. To this end we used the Falkenmark water stress index (Falkenmark, 1989) in 16 countries with severe water scarcity and 4 with moderate scarcity. Using this information, the regression models used previously were broadened to include artificial scarcity variables. The results revealed that it is difficult to reject the negative influence of scarcity on

economic growth, the inverted U relationship defined in theoretical terms is maintained, and similar results are obtained for the water optimum use rate and for growth elasticity. The analysis permits to conclude that it is particularly difficult for countries that are subjected to water scarcity to accelerate growth through better water use. The author concludes his study with some statements that raise some doubts about the optimistic results obtained. Firstly, he indicates that the analysis should have a more regional character because of the spatial variability of the water scarcity phenomenon. Secondly, he mentions the fact of counting transnational water sources as part of the country’s resources, which may be subject to political, technical or economic restrictions to use. Thirdly, he points out that the problems caused by water shortage may be more serious in some key sectors like agriculture, than in the economy as a whole. Fourthly, he states that the analysis carried out only considers water for productive use and does not take into account its environmental uses. Finally, he emphasizes the limitations of considering the government as the single water supplier, if we take into account the government’s incapacity to guarantee socially efficient supply and use levels in different countries (Dosi and Easter, 2000), conditions that require the active involvement of the private sector in water supply and other related services. 4.4

Relationship between water resources and poverty: the water poverty index. We have mentioned different ways in which water affects economic growth, although

the importance of water is much broader because it is an element that is essential for human development and social welfare. Sullivan (2002) underlines that at an aggregate level, countries with higher income levels tend to show higher water consumption. It is also pointed out that the lack of appropriate, reliable water supply leads to a poor health status and low GDP (Lawrence et al, 2003). The Water Poverty Index (WPI) was developed to establish a more objective relationship between water availability and population welfare. The WPI is an interdisciplinary index that intends to quantitatively estimate the extent that water scarcity impacts human welfare, making it possible to rank countries and communities within countries in order to make comparisons. The index is still in a development stage, it is of an aggregate nature, and it is built on the basis

of national information.

It is expected, however, that local indices may be

developed in the future that will permit greater precision in the construction of national indices. The construction of the index required quite a holistic view of water availability and water use. Methodologically, the WPI is similar to the Human Development Index (HDI), as it is a combined welfare indicator, besides simply considering income aspects related to water availability. Thus, factors like the physical availability of water, the population’s access to water, sustained access, aspects related to water use and environmental considerations about water quality and the ecology sustained by that water, are taken into account in its calculation (Lawrence et al., 2003). Each one these elements is one subcomponent of the index.

The resource component intends to quantify the availability of water

resources on the basis of two independent weighted indices, one of internal water resources, and another one of external water inflows.

The access component includes three

subindices: the percentage of the population with access to safe water, the percentage of the population with access to sanitation, and an indicator of the relationship between irrigated land and internal water resources. The capacity component intends to capture the socioeconomic elements that have an influence on the population’s access to water, including per capita income adjusted for the purchasing power of the currency, the mortality rate of children under 5 years of age, the UNDP education index from the Human Development Report 2001, and the Gini coefficient which gives the distribution of income across the population. The use component is made up of three subcomponents: the domestic water use per capita adjusted for industrial water use per capita and agricultural water use per capita, all of them approximations of the efficiency of the use of water in every sector. Finally, the environmental component includes a series of environmental indicators related to water provision and management including the Environmental Sustainability Index of the World Economic Forum et al. (2001). More specifically, the environmental component includes measures of water quality, water stress, regulation and management capacity, capacity of providing information, and biodiversity. In the abovementioned study, the WPI was applied to 140 countries and the results were presented by component together with the HDI and the Falkenmark Index (indicator

of water resources per capita). The study reached a series of very interesting conclusions to contribute to the debate about design and implementation of national water policies, thereby contributing to the identification of the main aspects which they must focus on. The first conclusion of the analysis that was derived by ranking the countries is that most of the countries with a higher WPI are developed or richer developing countries, with a few notable exceptions like Guyana (8th) and Belgium (87th). Some relevant observations are that some highly developed countries like the United States and New Zealand rank low in the use of water component. South Africa scores low in the resource component, but ranks high in the rest of the WPI’s components, which is interpreted to reflect its progressionist water access and management policies (Lawrence et al, 2003). In their analysis, the authors emphasize the low correlation between the WPI and the Falkenmark index (ρ = 0,32), which suggests that the WPI adds relevant information in the progress towards sustainable water provision. The information contained in each of the subcomponents is more relevant than the final value of the index. There is a low correlation among components, except between the access and capacity components. This result is considered good as a high correlation among components is one of the main criticisms made to combined development indicators. The authors state that they expected a stronger negative correlation than the one observed between the resources and use components, as a smaller quantity of water available should encourage more efficient use; and between resources and environment, as scarcity should motivate to greater implementation of water conservation measures.

Both results, however, were not observed in practice. The

moderately positive correlation between WPI and HDI was interpreted that water indicators differ slightly from development indicators in general. As a possible way to improve the index, the possibility of giving greater weight to the access and environmental components is being discussed, and less to resources, as resources are a given variable, and the most important aspects are water resource management and distribution decisions. This observation is in line with Rosegrant et al. (2003), who point out that the future of water and food production heavily depend on factors subject to decisions made by the population, like water distribution, investment in infrastructure, and technological change, among other. A last methodological improvement proposed is that the WPI should include some aggregated measure of investment in water in

its calculation, data that unfortunately were not available at the time the study was conducted.

5.

SOCIAL

CAPITAL

AND

INSTITUTIONALITY

IN

THE

PROVISION OF WATER SERVICES The previous sections have emphasized the importance of water for economic development and the global challenges that water scarcity poses on water planning and management. As it has already been pointed out, in many places around the world, water scarcity is the result of economic conditions that determine inefficient management and use of existing resources. For example, the definition of water as a free-access public good brings about allocation inefficiencies as well as environmental degradation problems because, as Perman et al. (1999) point out, in these situations, prices do not reflect the actual costs and social benefits of providing water. Given this inefficient, unsustainable consumption pattern, there is a need to design water use systems (Zilberman and Lipper, 1999). The water use systems solve the problems of free access by establishing the exclusion. Even so, establishing water use or water rights alone is not sufficient to guarantee optimum allocation from a socioeconomic point of view. In fact, empirical evidence shows that even if water use or water rights has been defined, in some cases there is still a deficient management of water resources and there is still room to accelerate economic growth through adequate water policies measures. In this regard, a greater social capital and an improved institutional framework are key points in the policy reforms practically all over the world. Social capital is defined as a set of relationships that occur among individuals, institutions and between individuals and institutions (Pearce and Atkinson, 1998, quoted by Dosi and Easter, 2000). The existence of institutional arrangements that permit an adequate management of water resources makes it possible for countries to better manage the restrictions imposed by the physical availability of water.

Such is the case of some

countries like Egypt or South Africa, which by means of successful water management policies and practices have been able to manage the restrictions of the chronic water scarcity those countries suffer (Pasha, 2003; Lawrence et al, 2002).

The World Bank (1985, quoted by Spulber and Sabbaghi, 1998), indicates that policies like subsidy reductions, promoting more efficient irrigation technologies and water reallocation from low-value agricultural use towards cities, will permit avoiding conflicts derived from water shortage in the Middle East and the north of Africa. It is argued that this kind of measures would permit users to pay for the real cost of water, driving changes in the choice of crops and better technical and financial management of water. Growing water scarcity has forced planning personnel to reformulate the water allocation systems looking for socially efficient solutions. The starting point for a thorough reform of the water allocation systems is recognizing that water is an economic good with a cost of opportunity of use. This view makes it possible to internalize the cost of supplying water to the decisions of the planning entity and water users (Dosi and Easter, 2000). Efficient water allocation is a complex problem subject to a high degree of uncertainty because of the independence of flows in different points in time and their dependence on uncontrollable climatic factors. From a theoretical point of view, a socially efficient allocation is achieved when the net marginal benefit of water use equals its marginal opportunity cost or shadow price and when the marginal benefit of use is balanced between the different sectors of water consumers, both conditions subject to a determined water availability for each point in time. Under these circumstances, the net social benefit (understood as the difference between the social benefit and the social cost) of water use is maximized (Donoso, 2002). There are a variety of institutions which may implement optimum water allocation. According to Rosegrant and Gazmuri (1994), alternative water allocation systems may be classified as follows: (a) allocation by the authority, whether through administrative or negotiation processes; (b) allocation based on opportunity costs; and (c) allocation based on market of tradable water rights. Each one of these systems shows significant differences and or based on different principles. In the systems where water is allocated by the authority, it has been seen that the increasing difficulty to meet the population’s water demands has determined reformulating the role of the governments in the provision of water services. Centralized water allocation systems, where the government is the owner of the water supply industries and whose management approach is focused on water supply, have been the benchmark to define

public policies, generating problems related to water supply scarcity and poor water quality. In this context, the traditional government approach has been investing in water infrastructure and formulating water management policies and allocation systems. Consequently, it is stated that the government has not been able to create effective incentives to optimize global water production and distribution, assigning a value to water services that represents their true opportunity costs.

It has not created incentives to

promote efficient use of water nor adopted management and technological innovations. On the other hand, water supply and distribution systems in State hands has kept the water industry isolated from the rest of the markets, which does not contribute to generate economic incentives for greater water allocation efficiency through price differentiation and quality (Spulber and Sabbaghi, 1998). In the agricultural sector, the government’s role has tended to transfer the responsibility for irrigation management to farmers (Vermillion and Sagardoy, 1999, quoted by Van Koppen, 2003), which in some areas has resulted in an absolute lack of support to irrigation projects.

In many developing countries, irrigation initiatives are

carried out by the same producers as a response to market opportunities. In this scenario, the role of the state must comprise not only building irrigation works, but also providing information, facilitating investment, improving access of producers to the markets, and improving marketing and input supply channels. The concept of privatization has been used in a broad sense, referring to situations where water industry policies and institutions have been reorganized, with or without the involvement of the private sector (Dosi and Easter, 2000). Privatization, strictly speaking, implies the transfer of property from state-owned companies to the private sector or the transfer of services formerly furnished by the State to private hands. An argument against privatization is the divergence between public and private objectives making it more difficult to evaluate private management performance. Also, the private sector’s focus on profit earning creates doubts about the access to the goods and services provided by the privatized companies. The supporters of privatization, on the other hand, argue that the variety of objectives and restrictions of state-owned companies contribute to their inefficient management, something that does not occur in the private sector, whose natural target is economic efficiency. Privatization does not reject the important controlling role of

the State to protect the interests of consumers and the industry’s sustainability, through quality control mechanisms and the specification of technical and rate restrictions. Although the role of the state is clear in this regard, privatization may serve as a means to generate income for the government through tax collection, or as a way of transferring such resources from the taxpayers to the final consumers. The regulatory aspects of the privatization of the water services and the creation of markets must be mentioned.

An adequate price policy is fundamental for a successful

privatization of the sector. The natural trend has been to supply water at a very low price, ignoring its true economic value. This type of policies has brought about water misuse and overuse, which may be reverted with a rate increase, which will force people to use water more responsibly. As Dosi and Easter (2000) point out, the need in developing countries to stimulate water conservation, and at the same time the need to maintain water rates at levels in which the water bill is not a significant part of the family budget, make rises in the prices of water socially desirable in most of the cases. In addition to the rates, it may be necessary to modify the environmental legislation, which may severely restrict water allocation between the different uses, particularly when there are environmental uses involved, without considering the net social benefits derived from those transactions.

Another

relevant point is coordinating the local legislative systems when there are interstate or international water courses subject to different regulatory frameworks. In these situations border problems generate uncertainty and result in inefficient use and poor investment decisions (Dosi e Easter, 2000). Also water resource protectionism may restrict the tradability of water between the different geographic zones.

In this regard, trade

liberalization measures like free-trade agreements must contribute to eliminate those restrictions, as it is expected will occur with the NAFTA in North America (Frerichs and Easter, 1990, quoted by Dosi and Easter, 2000). It is worth noting that there are a series of accepted general, economic, equity and cultural principles regarding the design of water resource allocation systems.

The

integrated sustainability and management of water resources are currently part of the general principles of modern water legislation. This is a common characteristic that unifies national legislations and crosses continents regardless of legislation origin.

From the point of view of economic and equity principles, the most important criteria that must be taken into account to determine the “best” allocation system are the efficiency and distributive criteria. The efficiency criterion basically consists of maximizing the net social benefit. The distributive aspects of the allocation system are extremely important because this implies assigning determined costs and benefits to the different members of society. Thus, initially assigning free water rights implies transferring wealth to the user. On the other hand, it is important to underline that the regulatory and institutional frameworks must take cultural aspects into account as well as the macroeconomic context of the society where the systems will be applied. In other words, the water legislation in each country must reflect its water reality and at the same time express the population’s general wish of how water must be used. It has been concluded that the volume of water in a country is inversely proportional to the volume of its legislation and public authority intervention. In Europe, for example, comparing the water legislation of a Mediterranean country like Spain and that of the Nordic countries has made it possible to confirm this axiom. In the United States, local entities are responsible for water development, with the exception of irrigation water, which is heavily subsidized in the west of the country. This is a way of implementing the general wishes of the citizens in relation to the way water must be used. Nevertheless, it has been pointed out that even in the case of irrigation, the role of the State has tended to transfer the responsibility towards local user associations (Dosi e Easter, 2000). The United States national water policy has been limited at a federal level to control water quality, and state or local entities are in charge of allocating water and fixing prices. At a central level, the concern has been focused on controlling pollution of surface courses and controlling point pollution sources, investing approximately US$700 billion in the 1972-1996 period (Dosi e Easter, 2000). Water markets in the United States have been set up in the West because of the arid climate and the rapid growth of economic activity in that part of the country. It has been shown that the market’s dynamism in that area is highly related to the rainfall for a determined period. The introduction of the water markets has made it possible to balance water supply and demand and to lessen the effects of severe droughts in the area (Easter et al., 1998, quoted by Dosi and Easter, 2000).

The European Union has also taken steps to decentralize the water sector. Despite a generalized preference for the local management of water resources, the transnational character of most of the rivers in Europe makes us think in the need of generating a common water policy or at least the need to integrate the different national policies. At a continental level, the first common initiatives of European Union countries in water matters started in the 70s and they were based on defining water quality standards for surface courses used to supply drinking water (Dosi e Easter, 2000). For example, the French legislation establishing that water rights are public and not tradable was issued, in part, in response to the requirements that emerged with the implementation of the Common European Market. At the same time, although in France water is considered mostly as a public good (cours d´eau domaniaux), the existence of private waters (cours d’eau non domaniaux, eaux pluviales, eaux souterraines, eaux minerales et thermales) is accepted, particularly respecting acquired rights, which derive from previous legislations. Public waters may only be used by private parties by obtaining a concession, which may acquire different forms in accordance with the extension and the scope of the rights conferred to the holder. In addition, France is characterized by a complex and efficient water management system. Thus, it is not surprising that many ministries are involved in the public management of water. As a result of the legal and administrative reforms carried out over the past decade, such functions have been centralized in the Ministry of the Environment, including the General Water Authority, which despite its name does not have the total attributions over water. In Australia waters belong to the state. Water extraction is carried out under a license, and the authorities assign a flow for environmental purposes. Typically, the state agency responsible for allocating water provides wholesale services supplying water to distributors, and it also provides retail services supplying water to irrigation water users. Before 1980, licenses to extract water were linked to the land. During the ‘80s this was modified in most jurisdictions and a water market was introduced. A number of restrictions were established, however, limiting the markets ability to rationalize water use. At the beginning, only temporary transfers were permitted, between irrigation water users, and within a geographic limit. This was carried out under supervision, and transfers affecting third parties were forbidden. With time some of those restrictions have loosened, permanent transfers have

been permitted, as well as transfers across geographic zones (including between basins). In the case of urban water, a double rate system was established, including a fixed charge for connection and a variable rate for consumption. Although these charges do not cover the system’s total cost, they improved water allocation, encouraging consumers to save. Crossed subsidies were also eliminated. In some districts this measure postponed new infrastructure works. In the case of irrigation, reforms were mainly focused on increasing prices. The higher prices permitted recovering costs and improved the incentives to save water; the price rise was implemented despite the opposition of the farmers. The tradability of water rights was introduced. As a result of these changes, tradable water rights, and the introduction of a water market, it was expected that water would be transferred from less valuable to more valuable uses. Nevertheless, because of existing restrictions this has not occurred as rapidly as expected. On the other hand, people in Mexico think that because water belongs to the State, every citizen has the free constitutional right to water.

The recent reforms promote

establishing private rights over water use, thereby permitting privatization of supply and drainage services management, introducing some new principles like the need to conduct a cost-benefit analysis in the application of regulations. At the same time, greater emphasis has been given to several water conservation measures including water recycling. These changes have created an environment that currently permits water-related laws and regulations to be reformed in a more expedite and rational way than in the past. A new law was issued in Mexico in December 1992 that completely changed the country’s groundwater distribution system, permitting the total privatization of a basin in order to create a market of water rights. This law will make it possible to control groundwater extraction in highly exploited areas by limiting the availability of permits. In Spain, all surface waters, groundwater and atmospheric waters are considered public property, therefore, the State is in charge of their management and determining their allocation in accordance with a strict priority established by law. The riverbeds of natural flows, the beds of lakes and ponds, and groundwater aquifers are also considered public property owned by the State. At present, Israel is implementing a very efficient water conservation, recycling and allocation policy. These measures, however, must be strengthened with water conservation

incentives at a small and large scale. There is consensus among experts that wastage or poor allocation of a significant part of the waters in Israel is due to the lack of adequate water pricing policies. The rate currently charged for water use is considered very low, especially in the agriculture sector, where the low price is due to the fact that it is almost completely subsidized. This is the result of the strong political influence of the agricultural sector, which presses the government for low rates. Experts in price fixing policies assure that this subsidy to the farming sector must be gradually eliminated. To that end, they propose an institutional change, namely, that the Water Delegation, the state agency in charge of managing water, which reports to the Ministry of Agriculture, be transformed into a private institution. An independent institution will be able to design and implement a neutral water system, without favoring any of the country’s specific productive sectors, like agriculture. Argentina, on the other hand, has a federal government, which implies that each State (Provincia) that makes up the Federation has sovereignty to rule in all matters that have not been handed to the Federal Government. According to the Civil Code, there are public and private waters. Public domain is determined by the Federal State, the provinces and the municipalities.

Most waters in Argentina are public property, private waters being

restricted exclusively to those waters that emerge and die in a farm, and rainwater and springs in a farm. The African governments were also encouraged to carry out a thorough reform of their water policies at the beginning of the ‘90s.

That reform is based on the

acknowledgement of the fundamental role of water in the region as a motor to eradicate poverty and to improve the population’s health and life conditions. The new focus is on the integrated management of water resources, an approach that emphasizes five essential points (Van Koppen, 2003): management at a basin level; minimum management to achieve an appropriate level; approaches focused on demand, property and participation of all stakeholders, especially women and youths; and promoting know-how and transferring information for institutional sustainability and preventing conflicts. The practical application of those principles requires acknowledging the specific nature of the water scarcity problems in Subsaharan Africa.

Those problems are

fundamentally of an economic nature because currently there are sufficient resources but

there is lack of an adequate incentives structure to develop water resources. In general, the transfer of water from agricultural use to other uses has been proposed; however, an approach of this type does not acknowledge the lack of storage infrastructure and infrastructure to conduct the water existing in the area. In addition, agriculture has a crucial social importance for Subsaharan African societies, as of most of the population lives from agriculture, and it is the most likely path toward economic development in those societies. To achieve agricultural development, Africa must intensify crop management practices. In this respect, a greater and more efficient use of water is a key aspect. The development of infrastructure in Subsaharan Africa must be targeted at simple, low-cost technologies that may be operated and maintained by the same community, which does not rule out the need for State investment in larger water infrastructure works. Transferring irrigation management to the private sector is another essential point for the success of water reform in Africa. Even though initiatives have already started, in practice, they have been materialized in the elimination of support to irrigation projects (Van Koppen, 2003). For these transfer strategies to operate, a technological design is needed to permit decentralized management, clear land and water rights, efficient marketing and input supply channels, credit facilities, and a synchronized transfer process, together with institutional capacity to internalize the new responsibilities (Shah et al., 2002, quoted by Van Koppen, 2003). Another pillar in the integrated management of water resources is acknowledging water as an economic good, which makes it possible to generate water right systems. In Subsaharan Africa, however, there is an indivisible connection between definition of rights and cost recovery (Van Koppen, 2003). This perception motivates the population to interpret the establishment of water rights as a hidden way in which a profit-seeking bureaucracy uses to charge more taxes. With regard to water for irrigation use, it has been pointed out that before discussing which farmers should be exempted of taxes, it would be necessary to determine whether farmers should pay for irrigation water, considering that there are other significant consumers that obtain sizable profits and that deprive the rest of the population of water in times of shortage, like mining. The institutional framework in Subsaharan Africa is still precarious to think about decentralization systems based on privatization of state-owned companies or the creation of water right markets. It has been

suggested that synergies between government laws and local arrangements must be sought as an effective way of facing problems derived from the deficient definition of water rights. In addition, establishing priority uses or basic rights is an alternative that would permit governments to guarantee a minimum supply for domestic and industrial uses. In Chile, the first document that regulated the use of water dates back to 1819, drafted by Bernardo O’Higgins, who issued an Executive Decree defining the dimensions of an irrigation water user, a water sales system, and the responsibility for water intakes. The Civil Code came into effect in 1857; it is the first instrument that defines that “rivers and all waters flowing through natural riverbeds are national property of public use”, besides regulating that the access to waters shall be carried out through the “mercedes”, which “are conferred by the competent authority”.

The Water Code of 1951 continues with the

principles of the abovementioned Civil Code, the most important of which is that waters continue being national property of public use. The Water Code of 1930 introduces the “Water Right” concept, and the Water Code of 1951 further elaborates that concept establishing that “The Water Right may only be acquired by virtue of a merced conferred by the President of the Republic in the manner established herein.” The Water Code of 1967—because of a change in the macroeconomic and political context towards a more centralized political system—strengthens the concept of waters as public property and “changes the juridical nature of the Water Right”, the new nature consisting of “giving the Water Right the character of a real administrative right.” The new juridical nature of the Water Right consists of giving it the nature of a real administrative right, where the State confers the use of the national property of public use subject to public right rules. The State confers the use of waters but never the title over them.

Water Rights are therefore administrative rights that expire, and the water

reallocation process subjects water to planning so that the water right is exercised on the basis of the “beneficial and rational use rate.” The Code eliminates the list of preferences and gives priority to drinking water and potable water. It determines the types of industries and agricultural businesses, as well as water use technologies preferred for a geographical area. On the basis of that information, the maximum flows that can be used are determined. After the political changes that took place in Chile in 1973, the economic paradigm changed from one where the State was responsible for protecting and making an optimum

allocation of resources, to one where the market is responsible for the efficient allocation of resources. Therefore, the Water Code of 1967 stops depending on the macroeconomic model and the political context. Thus, the authorities and ministers of the time who managed the country’s economy provided the guidelines to draw up a new Water Code. This work was commissioned to a team of lawyers and hydraulic engineers, and the underlying philosophical principal was “entrepreneurial freedom”. This implies acknowledging that the individual is the maker of its own destiny and that he has the capacity to imagine, create, and above all, exercise his will, all capacities that must be respected so that he may develop them to their full potential (Figueroa, personal interview). The different instruments and ordinances mentioned above, including the Codes prior to 1981, contained restrictions for the creation and operation of an efficient water market consistent with the new economic system. These restrictions were related mainly to the definition of Water Rights, the degree of information available to users, transaction costs, the eventual damage to third parties, the methods used to settle disputes, the speculation of water, and the legal framework necessary for the market to operate properly. Therefore, as Hernan Buchi2, a former Minister of Finance, stated, "the purpose of the government in that area was creating solid property rights, not over water itself but over the use of water and to facilitate as much as possible an orderly operation of the market.”

In synthesis, the

underlying philosophy of the Water Code of 1981, in simple words, is establishing permanent, tradable water rights to permit efficient water use. Efficiency meaning that water is used by the agent that has the best valuation. A competitive water rights market that operates without transaction costs will guarantee, in principle, optimum water allocation in the terms indicated above.

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