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Working Paper WP00-2 August 2000
Cesare Dosi and K. William Easter
Center for International Food and Agricultural Policy
University of Minnesota
Department of Applied Economics
1994 Buford Avenue, 231 ClaOff
St. Paul, MN 55108-6040 U.S.A.
Working Paper WP00-2 August 2000
Cesare Dosi and K. William Easter
Cesare Dosi is Professor in the Department of Economics at the University of Padova and
Fondazione ENI E. Mattei, Milano (Italy). K. William Easter is Professor and Director of Center for
International Food and Agricultural Policy, Department of Applied Economics, University of
Minnesota, St. Paul, Minnesota (U.S.A.)
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1.0 INTRODUCTION .......................................................1
2.0 WATER SCARCITY AND SOCIAL CAPITAL ...................................2
3.1 Government and Market Failure ..........................................3
3.11 Market Failures ...............................................3
3.12 Government Failure ............................................5
3.2 Institutional Changes: Objectives and Constraints .............................6
3.3 Water Markets ......................................................7
3.4 Privatization of Water Services ..........................................8
3.5 Regulatory Issues .................................................. 12
3.6 The Intersection of Markets and Privatization ...............................14
4.1 The U.S. Experience with Privatization and Markets in the Public Water Sector ........15
4.11 U.S. Water Policy ............................................15
4.12 Privatization ................................................16
4.13 Water Markets ...............................................19
4.2. The European Union .................................................20
4.2.1 The Community Water Policy ....................................20
4.2.2 Member Countries ............................................22
5.0 FINAL REMARKS ......................................................25
FOOTNOTES ..............................................................28
REFERENCES .............................................................30
1Characteristics of Public and Private Goods, Market Power, and Externalities in
Water Sector Services ....................................................35
2Market Conditions and Public Policy for Efficient Provision and Management of
Water Resources ....................................................... 36
3Privatization Options Found in the United States ..................................38
4Water Transfers Using State Water Project Facilities 1998 ...........................39
5Average Pricing (m3) for Household Water Services
(water supply+wastewater services) in European Countries ..........................40
by Cesare Dosi and K. William Easter**
Increasingly, water scarcity is described as a major challenge facing the world. However, its
definition remains a controversial issue. For instance, water scarcity is not an absolute concept.
Communities truly facing water scarcity are those where basic human requirements can only be satisfied
by some very basic changes in life style and/or levels of living. Developing new supplies and improving
water management will not provide enough water, given existing water use patterns. Only a limited
number of countries fall in this category. A larger number of countries face water scarcity because they
need to make some basic changes in their water management including, in some cases, infrastructural
changes to facilitate management. Another group of countries have water scarcity and will need to
make both management changes and infrastructural investments to develop their water supply.
Policy options do exist. Most of them share the objective of treating water and water services
as an economic good, by making water demand less independent of users’ willingness to pay for it.
Policy options also include regulations and other instruments designed to help prevent the inefficient use
of open access water resources. The aim of this paper is to provide a broad overview of these policy
options by illustrating their rationale and possible caveats, both on the grounds of the available
theoretical literature and real world applications. We begin in section 2 by stressing the importance of
improving countries’ social capital (i.e., institutional arrangements and management rules for allocating
water between competitive uses) which deserves more attention when assessing scarcity problems and
identifying appropriate solutions.
In section 3 we describe a number of typical market and government failures, stemming from
water’s (and water services’) intrinsic features, as well from the traditional idea that people have a basic
right to receive water, and that water projects, per se, induce economic development. We then
concentrate on some economic approaches to improving water management, i.e., the establishment of
water markets and the privatization of water utilities.
In section 4 we focus on water policies in the United States and European Union. The aim is to
provide an overview of some ongoing developments, especially in regards to privatization and the use
of water markets. National statistics in both areas seem to show a relative abundance of fresh water.
Yet the persistent geographical water imbalances, the increasing importance attributed to quality issues,
the competition between traditional water uses and resources conservation, and a reconsideration of the
role of the public sector, are raising serious questions regarding the traditional approaches to resources
management and the operation and management of water services. Finally, section 5 provides some
general concluding remarks and policy suggestions.
The term scarcity is commonly used to describe smallness of supply compared with demand.
In the case of freshwater, both supply and demand are open to different qualifications and definitions.
As far as water supply is concerned, a frequently used indicator of countries’ freshwater availability is
the total amount of internal renewable flows, generally evaluated according to annual and long-term
average precipitation and evapotranspiration rates. Although (per capita) internal renewable water
flows may prove useful to highlight situations of relative abundance, or potential scarcity,1 they may
mask significant geographical unbalances, and inter-annual or seasonal fluctuations: ceteris paribus,
the higher these unbalances and fluctuations are, the more a country is prone to continual or occasional
water shortages.
Providing adequate supply has several components. It involves providing an adequate quantity
of water, of the required quality, where and when is needed. Fulfillment of these supply conditions
depends on a country’s capital endowments, namely on man-made capital-- infrastructures able to
(re)distribute water over space and time and water treatment facilities--and on a country’s social
capital. The latter concerns the relationships between individuals, between institutions, and between
individuals and institutions (Pearce and Atkinson, 1998). The empirical evidence suggests that
communities relatively poorly endowed with freshwater, but which have been able to develop
appropriate formal or informal resources management rules, perform better than societies which,
despite their theoretical global abundance, are unable to properly allocate water resources between
different users: ceteris paribus, the more binding are the economic and political constraints facing a
society in developing appropriate man-made or social infrastructures, the more water scarcity is likely
to emerge.
For water demand, a distinction should be made between water needs and the much larger set
of wants for water to provide additional goods and services (Lundqvist and Gleick, 1997). Tracing this
borderline is not easy, in that the concept of needs reflects individual and social value judgements,
which vary over time and space. But if the term need is intended to mean “basic human requirements,”
then it is possible to draw a distinction, within water demand, between what is independent of economic
and social conditions, and what can be manipulated through prices, or other social and legal rules.2 In
this respect, it must be emphasized that in many countries, the lack of institutional arrangements aimed
at regulating private appropriation of common (open access) resources, and the subsidization of water
services, have helped transform the concept of water demand into one that should be more properly
described as “water requirements under the expectation of quasi-null cost” (Arrojo, 1999).
The failure to treat water (and water services) as an economic good is also generally
responsible for a circularity between rising demand, inadequate supply, and increasing (perceived)
scarcity. When water is demanded at prices below supply costs, consumers do not provide enough
revenue to expand water supply systems (Garrido, 1999). Consequently, users feel deprived of what
they perceive as a need, simply because water demand has been derived, de facto, substantially
independent of their willingness-to-pay for it.
In short, water scarcity is not, always, an absolute concept. Truly water scarce communities
are those where basic human requirements cannot be satisfied without basic changes in levels of living.
The number of water scarce communities becomes large only when you add those who lack the
economic, administrative, and political ability to reduce the water resource constraint. Many areas,
around the world, fall within this latter category. But in many of these countries the current unbalances
between water demand (wants for water) and supply could be bridged through improving their “social
capital,” i.e., through appropriate institutional arrangements (demand-side management reforms).
Often, we have had to be reminded how critical institutions are in guiding the use of natural
resources. We also need to be reminded that if one wants to change the use of a resource such as
water, then institutions will usually have to be changed. This may involve changes in federal, state or
union laws or regulations. It can also mean changes in the tax code that will change private investment
incentives. The key thing to keep in mind is that institutions create incentives and disincentives which
will determine how society uses its water.
3.1 Government and Market Failure
Increasingly, water is being talked about as a limiting resource that will constrain future
increases in food production and require many people to change how they use water for hygiene and
recreation (Postel, 1999). For most of the United States and Europe this specter does not seem to be
imminent. However, future water availability may well depend on how fast both regions pursue policies
to improve water management, including the introduction of water markets and the privatization of
water utilities. Traditionally, water has been cheap and in some sense almost a free good. This has
weakened the link between any pending scarcity and innovation. Thus, while we work to conserve and
substitute for scarce resources, we continue to use “cheap” water lavishly. How did we get into the
current situation of excessive water use?
Unfortunately, water has a number of characteristics which create market failure in its
production and delivery to users. These market failures, combined with the ideas that people have a
basic right to receive water and that water projects induce economic development, have impelled
governments to intervene heavily in the provision of water.
3.11 Market Failures
Fresh water is both a stock and flow resource that is highly interconnected and vulnerable to
market failures. The interconnections makes most water use activities highly interdependent, resulting in
numerous (mostly negative) externalities (see Tables 1 and 2). For example, when upstream farmers
divert irrigation water, they may deprive downstream users of adequate water supplies, or they may
degrade the water quality. Thus, upstream users can create two distinctly different negative
externalities. Also, pumping groundwater can create externalities. These externalities can be
intertemporal, if there is little or no recharge; or seasonal, if the recharge is dependent on monsoons or
other periodic rainfall events. Pumping by one individual lowers the water table for others in the area,
either permanently (no recharge) or temporarily (recharge takes time) which increases their pumping
The natural characteristics of water, particularly its mobility and supply variability, make it
expensive to establish property rights based on the volume of water. Thus, most groundwater
ownership is tied to land ownership, while surface water rights, if they exist, are based on shares of a
flow or the volume delivered (appropriative rights) and on location (riparian rights) of land relative to
the water. Most of the surface water rights that exist in the western United States are appropriative
rights with their seniority based on the date of first diversion (appropriation) or use (first-in-use is first-
Where water rights have not been created, or they are attached to land ownership, the water is
essentially an “open access” resource (high cost of excluding users). This is the case for much of the
world’s groundwater. There is no incentive to save water and capture future increases in its “scarcity
rent” because your neighbor will pump what you do not use. This is a serious problem where farms are
relatively small and wells are close together. Only a few areas have been able to establish groundwater
rights based on set allowable volume of water to be pumped per season or year (Blomquist, 1995).
Again establishing such rights is expensive to do because there are high transaction costs in determining
the water available over time and monitoring the volumes pumped without extensive user participation.
Yet future changes in technology are likely to reduce these transaction costs substantially and allow
countries to more cheaply establish and monitor volumetric groundwater rights.
Water’s natural characteristics also make it expensive to store and supply water where and
when people want it, and in the quantity and quality they want. In an effort to overcome these
problems, the public sector has weakened private investment incentives and made it more difficult to
prevent water development from creating natural monopolies by building large storage reservoirs and
large canal networks. Parallel canals and duplicate reservoirs, that would be necessary for competition,
are usually impractical both technically and economically. The large scale projects and potential
monopoly power has created widespread concern that private sector control over water might result in
exploitation of consumers. Fights over water, as shown in U.S. cowboy movies during the 1940s and
1950s, were based on actual events from early settlement of the western United States, and serve to
illustrate these concerns.
In addition to concerns about monopoly power and open access water resources, the intrinsic
characteristics of water, and of water services, have created the conditions for “public goods.” As with
groundwater, it may be difficult (expensive) to exclude individuals from using surface water supplies
either, technically or politically (use of water is a basic right), especially for farmers along a canal. Also,
at least for part of the season, there may be excess capacity in canals and in reservoirs so that supplying
one more users at the margin adds very little if anything to the overall cost of supplying water. Clearly,
this would not be true in periods of peak water use or drought. Furthermore, some systems may be
used close to full capacity most of the time. Still reservoir storage and canal delivery capacity can both
have the characteristics of a public good (nonrivalry and high cost of exclusion). Canal maintenance
tends to have similar public good characteristics because, again, it is hard to exclude individual users
from benefiting from improved maintenance, and one more farmer benefiting does not subtract from the
benefits going to other farmers on the canal.
Some of the services provided by water also have strong public good characteristics including
flood control, recreation, and the provision of a good aquatic habitat. Additionally, services such as
recreation and habitat preservation have experienced a significant growth in demand over the past
twenty years partly because they have high income elasticities of demand. Thus, in the future water is
likely to be allocated in larger volumes to services that have public good characteristics. Yet as Table 2
suggests there are a number of public policies that can help prevent these and other types of market
failures from creating serious problems.
3.12 Government Failure
Given these characteristics of water, it is not surprising that there has been heavy public
involvement in resource management and provision of water services. Yet the public provision of
water, based on the ideas that water projects create economic development and that water should be a
basic right, has led to a series of problems in water management. One set of problems is related to the
rent-seeking and budget-maximization incentives associated with government failure, combined with
government’s susceptibility to pressure groups. As a consequence water prices are set below both
marginal and average costs. The end result is cheap water with prices that exclude “scarcity rent,” and
capital costs.
The rapid growth in water demands between 1940 and 1980 has forced a number of countries
to rethink their approach to water management. The shift in thinking has been slow in coming but
seems to have taken hold in some countries. The new approach has involved changing the role of
government in managing water. More emphasis is placed on water as an economic good and less on
the idea that since people have a basic right to water it should be provided no matter what the cost.
There is a growing realization that water management provides a bundle of services that can be
divided up, with some of the services better (more efficiently) provided by the private sector (Easter
and Feder, 1997). By unbundling services, the public sector can maintain its role where it is most
important, i.e., protect against monopoly power, negative externalities, the under-provision of “public
goods,” and the overuse of “open access” water. The private sector and market forces can then be
used to help better manage and allocate water services.
The western United States, Chile, and Mexico have used the water markets approach fairly
extensively over the past two decades. Water markets have also been developed for groundwater in a
number of countries (Easter, et al., 1998). The privatization of public water entities has occurred more
extensively in Europe and Latin America. England was one of the leaders when it sold off its public
water assets to large private companies in 1989.
Why this difference in emphasis between the U.S. and Europe? This question is not easy to
answer but it may be associated with the relative importance of the domestic water supply compared to
irrigation. Where irrigation is important, it is the largest user of water. Consequently, when water
scarcity and the need for change hit Chile, Mexico and California in the United States--where irrigation
is important--they made use of markets to improve water-use, increase efficiency, and save water. In
contrast, when England decided to privatize public water entities, it was in response not so much to
water scarcity but to a government budget scarcity and the need for future water infrastructure
investments. Privatizing water entities took them out of the public sector budget. In addition, it allowed
the government to make the monopoly provision of water contestable where different firms could
compete periodically to operate or manage a water system under a long-term contract.
In other European countries that have sizable areas of irrigation, such as Greece and Italy,
neither approach has been tried or adequately exploited. Only Spain has shown some interest in
establishing water markets.3 Again, they seem to be emphasizing the basic right-to-water as opposed
to water as an economic good. Another reason for the difference in approach could be the difference
in past institutional arrangements. For some countries, past institutional arrangements may have
lowered the transaction cost of making new institutional changes. For example, the western United
States and Chile both had some experience with establishing tradable water rights.
3.2 Institutional Changes: Objectives and Constraints
Clearly, as a country takes stock of its water resources and considers the need for institutional
change, they have to spell out their objectives and potential constraints. How important are efficiency
considerations relatively to equity concerns? For example, how important are concerns about potential
monopoly rents, or the ability of the poor to pay for a reliable and clean water supply? If the decision is
to move toward an efficient allocation and management of water over time, a number of institutional
arrangements need to be in place.
After examining their objectives, many states in the United States and countries in Europe
would probably find that in the last two decades a higher priority has been given to cleaner water for
recreation and ecological uses. This is illustrated by the decision to reallocate some of the water going
to irrigation in the central valley of California to improving water quality for fish habitat.
Another objective that is important for some countries is the desire to reduce public spending,
especially for large projects involving big physical changes in natural water systems. This is important in
the United States as illustrated by the fact that the last major United States federal water project (the
Central Arizona Project) was approved for construction over 25 years ago. European countries also
want to reduce public spending on the delivery of water services and are focusing on water quality for
domestic services.
In designing their water institutions, European countries are more constrained because of the
international nature of most of their river systems; most European rivers cross three or more countries.
In the United States, only a few rivers cross more than one country, and those that do, cross only two
countries. For example, the Mississippi River basin is almost totally within the United States’
boundaries, while the Great Lakes involves only Canada and the United States. The United States,
along with its two neighbors, has generally developed institutional arrangements (such as the
International Commission on the Great Lakes) to coordinate the management of much of its
international water resources. In contrast, if the Mississippi or the Great Lakes were in Europe, water
management would involve at least six or more countries. The February 2000 cyanide spill from a
Romanian gold mine illustrates this coordination problem. The spill first polluted the Tisa River (which
flows into Hungary and Yugoslavia) before it reached the Danube River (Associated Press, 2000).
3.3 Water Markets
Establishing the institutional and organization arrangements for effective water markets may not
be worth the cost, until it is clear that water is scarce (high value at the margin) or soon will be scarce.
The eastern United States and northern Europe have not reached this level of water scarcity and are not
likely to in the near future (these areas are primarily concerned with water quality problems). In
contrast, the western United States and southern Europe have sizable areas that face periodic water
deficits (during years with low rainfall) and could benefit from establishing such arrangements. The
transaction costs of making the needed institutional and organizational arrangements for markets can be
substantial depending on existing water laws, the degree of local management (user participation), and
the level of system infrastructure and management (Easter et al., 1998).
In many cases, water laws must be changed so that water users can sell or lease water for
varying lengths of time. This right-to-water use must be separate from land, and should be granted for
a long enough time period and be secure enough to provide users an incentive to invest in water
conserving practices. For surface water, this may require establishing priorities in water use, such as
the seniority system for appropriative rights as used in the western United States. In the case of
groundwater, where recharge is limited or nonexistent, volumetric rights need to be established. If
rights are not clearly established, groundwater users will ignore the “user cost” or “scarcity rent”
attributable to the groundwater stock. Consequently, the groundwater will be used more rapidly than is
economically optimal. If recharge is adequate to replace the water pumped, then rights need to be
established so that pumping does not interfere with neighboring wells or with surface water rights.
Where surface water and groundwater are closely linked, then water rights must be jointly established
on some noninterference or volumetric basis.
While establishing a system of water rights is essential, it is also important to develop a
procedure for registering, monitoring, and enforcing the rights. This can be done nationally, regionally,
or locally depending on how the region’s water management is structured. Many times it will be
cheaper to do it locally, particularly if water-user organizations are active. Where return-flows or
economic third-party effects are an important concern, some state or national involvement may be
necessary to assure that the interdependency in basin’s water use is taken into account. In some cases,
sales of water rights have been limited to consumptive use or not allowed between basins because of
possible third-party effects.
Once users can buy and sell water, institutional and organizational changes may be needed to
broaden the market and make it more competitive. For example, improvements in canal infrastructure
may be needed so that trading can take place over a larger area, e.g., canals connecting different
systems. In addition, management may have to be improved so that orders to buy and sell water can
be easily implemented. The managers may also need improved control structures so that they can
easily increase the flow in one canal and decrease it in another.
Another important institutional arrangement for effective water markets is some mechanism for
resolving conflicts over water rights and water delivery, such as a committee of respected water users
elected by the community. The role of such a group would be closely tied to how well the water rights
are specified and how they were established and distributed to users. If water rights are unclear, and
the distribution contentious, then there will be numerous difficult conflicts that may have to be resolved,
probably in court rather than by a committee of users. One of the contentious issues is likely to be how
much water is allocated to ecological and environmental uses. As suggested above, this issue will be of
growing importance in the future. Still, if water rights are clearly specified and their distribution is based
on past use, then most of the disputes can be resolved by an elected body of respected users.
Since the assignment and allocation of water rights generally involves the distribution of
significant economic rents, the allocation rules must be carefully developed in a transparent manner. In
many cases this can be done based on past use, much like it was done in Chile, where water-use
associations played an active role in verifying past use. However, this will not work when past water
allocations significantly exceeded actual supplies. In cases where you have overlapping claims for
water use, such as in Peru, then you may need a water court or tribunal to determine who has priority.
Another possibility is to uniformly reduce all claims enough to balance supply and demand during a
normal year’s water supply. Some combination of setting priorities and reducing claims could also
3.4 Privatization of Water Services
Reforms addressing the water sector have, particularly in Europe, concentrated on
reformulating public sector’s functions and activities, and on involving new actors in the supply of water
services.4 For instance there is a tendency towards decoupling or stressing distinctions between water
resource-planning and operation of water utilities. In addition, there is a trend towards introducing
more competitive pressures in the water industry, an objective often, although not exclusively pursued,
through involving the private sector in the operation and management of water utilities.
The latter process is generally broadly referred to as privatization of water services, though the
term privatization is sometimes also used to describe restructuring processes not necessarily involving
the private sector. These alternative processes may take on the form of decentralization, where local
authorities take over control functions which were previously state-owned, or the form of
corporatization of public firms. On the other hand, privatization, stricto sensu, occurs through sales of
previously state or municipally owned firms, contracting-out of water services, or through granting a
concession for a private company to run a water utility (Hall, 1997a).
Broadly speaking, the main theoretical justification for the involvement of private companies in
the provision of water services is to increase the water industry’s performance, i.e., to get better and/or
cheaper services (Cowen, 1997). In fact, the private sector is potentially capable of injecting
technological, financial and managerial resources which the public sector may be unable to obtain,
because of fiscal and bureaucratic constraints, and the lack of adequate incentives (Spulber and
Sabbaghi, 1994). This is also, in general, the prime justification advocated by governments when
embarking on a privatization process, although other economic and political considerations may
influence such decision. These considerations may include the desire to obtain receipts from
privatization to reduce public sector debt and/or finance tax reductions and shifting the cost of providing
previously subsidized services from taxpayers to water users. For instance, using privatization receipts
as a way of “laundering” taxation is not uncommon.5
Generally speaking, there are different means of introducing more competitive pressure in an
utility market. These means include: (a) product-market competition, (b) yardstick competition, (c)
competition for the market, (d) competition to supply inputs.
Product-market competition can be promoted in different ways, namely through allowing (i)
the installment of competing networks, (ii) private supply and retail competition, or (ii) common carriage
competition (Webb and Ehrhardt, 1998).
In general, installing competing networks is not a serious option in the water supply and
distribution industry (Cowan, 1998; Webb and Ehrhardt, 1998). Although it should not be always
ruled out,6 duplication of networks is generally undesirable, given the current state of technology, in that
it would imply losing scale economies and higher average water distribution costs.7 However, the fact
that existing main networks are naturally monopolistic does not mean that additions should be owned by
incumbent operators (Cowan, 1998). For instance, liberalization of water services could in principle
allow groups of consumers to supply themselves (private supply), or allow agents, willing-to-pay for
improved services (e.g. more secure water supplies), to buy water from new operators (retail
competition) (Webb and Ehrhard, 1998).
Shared use of existing networks by different firms (common carriage competition) is another
option for injecting competitive pressure in a utility market. For instance, competition in
telecommunications, public transport (railways), gas and energy have been, and are being mostly
pursued by regarding transmission systems as a separate enterprise, and by allowing more firms to
operate on the same system. However, opening up water distribution networks to common carriage
may pose specific problems that need to be carefully addressed. One specific issue is that of water
quality and whether the standards set can be safeguarded (Byatt, 1998). For instance, quality from
different companies sharing the same distribution network may vary, and once contaminated water
(water not satisfying existing standards) flows in the system, it mixes with and affects water quality from
other sources. This is a serious and challenging issue, but not an insurmountable problem (Byatt,
1998). Other network industries (e.g., electricity) face similar (though generally less severe) problems,
and must ensure minimum quality standard and technical compatibility in order to avoid damages to the
network (Webb and Ehrhard, 1998).
Although theoretically appealing, opening up existing networks is not a common mean for
injecting competition pressure in the water industry. Even in countries which have adopted a strong
privatization process, common-carriage is either prohibited by current legislation, or has not occurred to
a large extent. To our knowledge the only available example is the UK, where in 1995 OFWAT (the
Office of Water Services which regulates the water industry) has relaxed the definition of a qualifying
site for “inset appointments,”8 and allowed new utilities to supply large consumers in an incumbent’s
interconnected system by paying a fee for using the system. Only a few cases of inset competition have
occurred so far, but the interest manifested by various companies and customers to take advantage of
the possibility of common-carriage has had an effect on incumbent firms. In response to the threat of
competition, the vast majority of UK water companies have lowered tariffs for large users with cuts
ranging from 1 percent to about 25 percent (Webb and Ehrhardt, 1998).
Yardstick competition is a potentially powerful means for regulating and putting pressure on
incumbent firms when the intrinsic nature of the privatized utility does not allow the entry of an adequate
number of competing firms. In particular, as far as the water industry is concerned, because of its
naturally monopolistic features, a single company is likely to emerge in each location. However,
comparative competition between geographically separated suppliers may be injected (either through
setting an appropriate regulatory regime or through providing comparative information on tariffs and
levels of service) in order to stimulate firms’ efficiency and pass back efficiency gains to customers
(Byatt, 1998). To be effective, comparative competition requires an adequate numbers of comparable
agents, diversity of ownership, and consequent variety of management styles. It follows that a low
degree of competition within the whole water industry, and/or mergers between firms may significantly
undermine the potential advantages of yardstick competition.
As already underlined, the “liberalization” of water services does not mechanically imply
product-market competition. Large initial investment requirements and economies of scale inevitably
provide the incumbent firms with market power and reduce market contestability. However, the
sector’s performances could be improved through institutional arrangements designed to introduce
competition for the market. In other words, competitive pressure can be injected through awarding
the right to operate, in a given area, to the company able to submit the best offer in terms of overall
quality and cost of the water service.
In recent years, many countries have used competition for water concessions, and the
approach has often delivered substantial benefits to consumers (Webb and Ehrhard, 1998). While in
developing countries the involvement of private companies, through awarding the concession to run a
water utility, is often regarded as the only sustainable way to acquire an adequate infrastructure (World
Bank, 1994), in developed countries the prevailing rationale seems to be the improvement of the
operation and management of existing assets. For instance, in developed countries, franchising of water
services is often combined with public ownership of the main infrastructures (Cowan, 1998). One of
the best known example is the French gestion deleguée. Thus, competitive bidding for water
concessions has become one of the most common forms of competition (World Bank, 1993).9
The benefits, in terms of private companies’ performance, stemming from competitive bidding
for running water utilities, obviously depends on a number of conditions. These conditions include the
degree of competition in the water industry and the long-term credibility of initial contractual
arrangements. In the former case, similarly to yardstick competition, the effectiveness of the
competition for the market can be undermined by the shortage of competitive bidders. In this respect,
it is worth noting that the water industry is dominated by a small number of companies (Hall, 1999).
The majority of privatized water concessions in large and small cities on every continent are run by two
French companies: Vivendi (previously known as Generale des Eaux) and Suez-Lyonnaise des Eaux.
Where present, national companies often operate through joint-ventures with these multinationals.
As far as the contractual arrangements is concerned, a critical issue is the appointing authority’s
ability to maintain regulatory pressure on the agent during the life of the contract. For instance, while
there may be competition in awarding the concession, maintaining competitive pressure may prove to
be difficult, because of the lack of credible sanctions. Attracting private companies into the market may
be relatively easy, but expelling them may be much more difficult (Clark and Mondello, 1998; Moretto
and Valbonesi, 1998), because of contractual power arising from a company’s provision of an essential
service. This, in principle, makes short-term contracts the preferable solution, but they could prove to
be unattractive for firms due to the large sunk costs involved in acquiring the water concession.
Competition to supply inputs is another option for improving the overall performances of a
water utility. If there is sufficient competition between input suppliers (e.g. for billing and revenue
collection, maintenance of infrastructures), competitive procurement may allow for significant cost-
reductions which, in principle, could be passed on to consumers (or taxpayers). In the public sector,
competitive contracting out has become commonplace. For example, EU legislation imposes
competitive procurement on member states’ public sectors. However, paradoxically, the privatization
of a water utility may reduce the potential benefits of competitive contracting out of specific activities.
For instance, if a water concession is a concession in the strict sense, then the company running the
business is not subject to requirements of EU legislation, and it can contract out a specific activity (e.g.,
construction of new infrastructures), to a fellow-subsidiary, without advertising it for tender (Hall,
3.5 Regulatory Issues
Important regulatory issues have arisen as countries and states move to use water markets and
to privatize various aspects of their water supply and waste water treatment systems. In some cases
laws and regulations have had to be changed to allow water markets to develop and management of
public water and treatment systems to be privatized. In a number of countries this has involved changes
in tax codes. For example, the U.S. federal tax code was changed so that contract terms for private
firms managing public water and treatment facilities could be for more than 5 years. The removal of
these limits in 1997 eliminated a key constraint to private management of water and treatment services.
Under the old rules a facility that was managed under a contract of more than five years was not eligible
for tax-exempt financing. The new limits have been set at 20 years which allows private firms more
time over which to spread investment costs. These new limits should encourage increased private
sector involvement in the water sector. However, private ownership of infrastructure-intensive water
and treatment systems is still discouraged by the U.S. federal tax code. Municipal debt is tax-exempt
while private debt is not. Changes may also be required in U.S. state and local property tax codes
where municipal-owned facilities receive tax breaks but privately-owned facilities do not.
Another major problem facing privatization efforts are the regulations that have been introduced
at different levels of government to regulate water prices. There has been a general concern that private
firms or even public utilities may use their monopoly power in setting water prices. Yet it is not clear
that monopoly pricing is a legitimate concern for domestic water users. Given our need to encourage
users to conserve water and the fact that the water bill is no longer a significant share of most families’
income in the U.S. and western Europe, higher water prices are in most cases socially desirable. If
current price regulation is resulting in low prices and the overuse of water then maybe it is time for a
general deregulation of water pricing. This would also remove a barrier to privatization of water system
Modifications in environmental laws may also be necessary. In most cases these laws were not
written with a concern for efficient water use or the need to have water reallocated among different
uses. Consequently, many environmental laws and regulations tend to be inflexible when questions arise
concerning the trade-offs among different uses, including environmental uses. For example, the U.S.
Endangered Species Act may be used to prohibit water sales and transfers that may affect the habitats
of species that are listed as endangered.
There are a number of other regulations and laws that are likely to limit the future operations of
water markets in the U.S. and Europe. One which has received particular attention in the U.S. west is
the “public trust doctrine.” It has been used in U.S. state courts to limit private water uses that infringe
on certain public water uses such as water for fish habitat. The basic idea is that these public rights
have existed since the U.S. and individual states were founded and they must be recognized (Huffman,
1997). In some cases this means existing uses such as irrigation are faced with reduced water
A second set of issues arises because of the lack of consistent country and state laws which can
act as barriers to market transactions across borders or even within borders. The difficulty occurs
when rivers cross country or state borders and no sharing arrangements have been established among
the states or countries along the river. Even when appropriative rights have been established with
priorities set for each state or country, there are no priorities regarding the whole river. Thus
downstream users will find that what they receive for their water right is held hostage to how water is
used upstream, which will change over time. The uncertainty created by these transborder problems
will lead to inefficiencies in water use and poor investment decisions. A similar uncertainty is created by
laws that reserve rights for potential future uses or users. In the U.S., the reserve rights for Native
American tribes is an example where a certain quantity or share of water is allocated to a tribe whether
or not it is or will be used now or in the future (Colby, 1998).
A third area of concern involves specific national (federal) or state laws that restrict water use
and limit water transfers outside their borders. Many U.S. federal and state projects disallow sales to
users outside the districts that have water contracts (Howe, 1997). These institutional restrictions on
water transfers are primarily the product of national and state resource protectionism (Huffman, 1997).
In the U.S. the commerce clause prevents the states from limiting interstate commerce while NAFTA
may have a similar impact on future water trading in North America. The U.S. Supreme Court ruled in
the Sporhase Case that groundwater is an article of commerce and subject to the commerce clause of
the U.S. Constitution. As a result a state such as Nebraska cannot prevent the sale and transfer of
groundwater across its border (Frerichs and Easter, 1990).
A fourth institution that will limit water trading and increase transaction costs is the no-injury
rule. This is found in a number of institutional arrangements designed to protect third parties against
damages from water sales or transfers. These damages might be in terms of reduced return flows for
downstream users or reduced economic activity (fewer input sales, or fewer products to process
and/or market) in communities serving the irrigators selling water. “The big issue facing U.S. western
states and other areas introducing water markets10 is how to address third-party effects associated with
the reallocation of ... water without making transaction costs too high” (Howe, 1997, p. 83).
Fifth, the “beneficial use doctrine” connected with many water rights may no longer be
appropriate in a time of growing water scarcity and the development of water markets. Does beneficial
use cause owners to misuse or waste water so that they can maintain ownership? Furthermore, if water
sales are judged to show that the original owner is not making beneficial use of the water, it will
essentially prevent water trading. Both effects are undesirable and encourage inefficient allocation and
use of water.
A sixth set of institutions that may be important in fostering market exchanges and competition
are those that specify the obligations of those managing the distribution network. Control over this
infrastructure (by either public or private entities) can be used to block trades and prevent competition
from outside water suppliers. Even if the water distribution system is publicly owned, they still may
prevent use by other suppliers, even those willing to pay a transport fee. The restrictions on access
may be because of limited canal capacities or the exercise of monopoly power. Depending on the
motivation behind such restrictions, the solution will be different. In the first case infrastructural
investments are required, while in the second case legislation that gives all potential users access to the
canal system is needed.
3.6 The Intersection of Markets and Privatization
Although the water markets and privatizing water utilities have been discussed separately, there
is no conceptual reason why both could not be used to improve water use and allocation in a given
water system. A private firm could manage and operate a water system and water rights’ holds (users)
would pay the firm a fee for the service. The sale of water rights among users could be done through
the water firm or some other coordinating body. The water company would just have to have an up-
to-date record of who owns how much water. Whether or not a market or privatization of the water
system or both should be pursued depends on where the big inefficiencies are in the system. If the
problem is inefficiencies in the over all management of the water utility, then some form of privatization
would be good medicine. In contrast, if the problem is inefficient water use by consumers, then water
markets could be the solution. This would provide consumers a sense of the value of their water and an
incentive to use it efficiently. Effective water pricing by the water company could also have a similar
effect if it is based on the volume delivered to each user.
Of course, water markets have been found mostly in areas with a significant amount of
irrigation. They are generally used to transfer water among irrigators and from irrigators to water
companies or water utilities. There are also cases of individual households in rural areas buying water
from irrigators (Easter et al., 1998) as well as trade among utilities. In principle, transfers could also
take place among urban households, although no good examples currently exist. For urban households
the problem of allocation the water rights and keeping track of relatively small transactions may cause
the transaction costs to be quite high relative to the value of the water saved. Thus, for most urban
settings the preferred option is likely to be some form of privatization of the water utilities. Most of the
efficiencies gained from a water market could then be achieved if the water company is allowed to raise
prices enough to cover all costs plus some charge for the scarcity value of the water. If this generated
too high profits, the excess could be capture through taxes (e.g., license fees) by the public sector.
If equity concerns are important, and some of the low income users are having difficulty buying
water, either a two-price system or transfer payments could be used to deal with the problem (Hall,
2000; Boland and Whittington, 2000). In fact, any excess profits could be allocated to help the low
income households through rebates. Alternatively, the price of that volume of water required to meet
the “basic needs” of a family of four could be kept low while any water use above that amount would
be priced at the full cost of providing the water plus any scarcity rent.
The U.S. and European experience with privatization of the water sector and establishing water
markets has been partly guided by their respective water policies. As will be discussed below, their
policies regarding water quantity are limited at the federal level in the U.S. and at the European Union
level in Europe. Thus, the guiding water policies in the U.S. have been those from individual states
while in Europe they are from individual countries. This means that the privatization and water market
experience will vary from country to country in Europe and from state to state in the U.S. The
institutional arrangements developed to either promote or limit water markets and privatization are also
likely to be quite different. This situation could be changing in Europe as the Union is increasing the
uniformity of policies particularly regarding water quality. However, in the U.S. states’ policies are
likely to continue to play a central role.
4.1 The U.S. Experience with Privatization and Markets in the Public Water Sector
Part of the reason why U.S. federal water policies regarding quantity are limited, is the fact that
water development is viewed primarily as a state or local responsibility. For example, almost all cities
and towns are supplied by local or state entities. The major exception to this, for consumptive water
use, has been irrigation development which has in the past received large federal subsidies in the
western U.S. However, even for irrigation the federal role has changed as more and more
responsibility is shifting to local user entities. In terms of regulating water use the federal government
has had an even more limited role with regard to water markets and privatization. The major exception
has been court decisions regarding the sale of water across state boundaries (states can not restrict
such sales) (Frerich and Easter, 1990). For privatization the main impact of the federal government has
been the tax laws that favor public entities relative to private firms and federal regulations for drinking
water quality.
4.11 U.S. Water Policy
Currently, the United States does not have a comprehensive water resources policy. Since the
Water Resources Planning Act of 1965 was eliminated in the early 1980s, along with the river basin
commissions and funding for state planning assistance, federal water policy has been limited to water
quality concerns (Muckleston, 1990). Questions of water allocation and pricing have been left to state
and local entities as well as to a few regional entities such as the Great Lakes Commission that
remained active after the 1980s debacle.
Even with the federal policy concerning water quality, the responsibility for improving quality is
shared with the states. The water pollution control act was first enacted in 1948 and became the Clean
Water Act in 1972 with additional amendments in 1977, 1987 and 1996 (Davis and Mazurek, 1998).
The primary focus of federal water pollution control efforts has been on surface water and point
sources of pollution (end of pipe). Most of the federal funds have gone for construction grants for
municipal sewage treatment facilities, with over $700 billion spent from 1972-1996. This has added to
the capital intensity of the industry which is 3 to 4 times more capital intense than telephone and electric
utilities. Because of the focus on capital investment in municipal waste treatment, nonpoint sources of
pollution were almost ignored and the efforts to protect groundwater were at best fragmented. Thus
the major challenge for future water pollution control efforts in the U.S. will be to devise a system that
effectively addresses nonpoint pollution control issues and develops a more unified and effective
approach to groundwater protection.
4.12 Privatization
The United States in the past two decades has experienced a shift towards deregulation and
privatization in the public sector. Much of the shift was seen as a way to increase competition and
reduce costs through improved incentives. However, the water sector has only recently seen a move
towards privatization.11 Two factors seem to have stimulated this new interest. First is the financial
pressure, particularly for smaller systems, due to the general need to upgrade or expand water and
sewer systems. In some areas, such as the eastern part of the United States, the water and sewer
systems are old and in need of repair or replacement. The second factor, which is closely related to the
first, is the increasing cost of complying with new health and environmental standards for water quality.
Under the Safe Drinking Water Act Amendments (SDWA) of 1996, water utilities must meet stricter
requirements for removal of contaminants. The SDWA imposes a tougher standard on bacterial and
microbial contaminants and reduces the acceptable levels of harmful byproducts from disinfection. In
1998 the EPA estimated that compliance with these new requirements will cost over $1 billion annually
nationwide above and beyond the existing need to replace aging distribution and treatment infrastructure
(Seidenstat et al., 2000). The American Water Works Association, the nation’s largest drinking water
industry association, estimates 20-year costs of $325 billion for infrastructure (Seidenstat et al., 2000).
Interest in involving the private sector in managing water systems has been complemented by an
expansion in the activities of U.S. investor-owned water utilities. In 1994, Price Waterhouse found that
90% of the investor-owned water utilities surveyed had either closed transactions with or were
considering proposals to provide services to other cities (Beecher, et al., 1995). These private sector
activities in the U.S. have taken a number of different forms, ranging from outright private ownership to
public utilities contracting with private firms to do their water billing (Table 3). With the exception of
outright acquisition or ownership, the different options for privatization (listed in Table 3), involve either
contracting to supply inputs or concessions to provide management, or construction and design
services. Whether these arrangements provide adequate competition in the bidding process is not clear
and probably varies a lot across the U.S. Yet there is evidence to suggest that the design, build,
operate, and transfer option has significantly reduced construction and operating costs (Siedenstat et
al., 2000).
In a 1997 survey of 261 U.S. cities, 40% currently had some form of private/public partnership
and another 14% were considering proposals. The most common arrangement was for private design
and construction, particularly for water treatment facilities (71%). Meter reading (33%), billing and
collection (31%), as well as operation and maintenance (44%) were
the other private sector activities reported (Callahan, 2000). As this survey illustrates, public asset
sales to private firms is very limited. Asset sales usually take the form of transfers of small water
systems to investor-owned utilities that are located in neighboring areas. Until the early 90’s, the
federal tax code discouraged private ownership of infrastructure- intensive industries by making federal
construction grants available only to public utilities. Until 1992, if a public utility had received such a
government grant, the municipality was required to pay back 100% upon sale of the facility. At that
time a Presidential executive order on infrastructure privatization required that only the remaining
“undepreciated” portion of government grants be paid upon sale of the facility. Despite this change,
other disparities in the tax law, whereby municipal debt is tax-exempt while private debt is not, have
discouraged private purchase of water facilities. In addition, political concerns about maintaining
control over water resource facilities have stymied efforts to establish private ownership.
Most water facilities in the U.S. are constructed by private firms and managed by municipalities
after completion. This approach has been criticized for its lack of integration and inferior product
delivery. The Design-Build-Operate and Transfer Model has been used to give the private firm control
over the project in its entirety, creating a more integrated and better performing facility which has been
estimated to save roughly 25% of the construction costs and 20-40% of the operating cost (Siedenstat
et al., 2000). For example, Seattle’s Tolt River Project is estimated to have saved 40% compared to
the conventional model of private construction and public management of the facility.
Concessions for operations and maintenance are largely the result of tax code changes in 1997
as discussed above in the section on regulatory issues. Contracts for operations and management of
facilities have varied significantly by provisions and length. For example, Buffalo, New York held a
contract in 1997 with American Anglian Environment Technologies for operation of its system with a
guarantee of no layoffs (Seidenstat et al., 2000). Under agreements in Cranston, Rhode Island, the
private contractor paid cash up-front for significant capital improvements when the existing short-term
lease was renegotiated for 25 years.
Privatization has brought about increased entrance of foreign, highly-specialized water
companies and fostered consolidation among American water companies. The merger of French-
owned firms Aqua Alliance with Metcalf and Eddy in 1998 resulted in their management of
approximately 200 wastewater and 170 water utilities in the U.S. (Seidenstat et al., 2000). The British
have also entered into the American water utilities market, i.e., Anglian Water PLS has joined in
partnership with American Water Works, the largest U.S. investor-owned water company to compete
for O&M contracts as American Anglian Environment Technologies.
The potential for inter-utility cooperation between the energy and water sectors provides
another interesting potential for new competitors in the water industry. Deregulated, newly competitive
energy utilities could choose to ally themselves with large, captive customer bases of water utilities in
order to achieve efficiencies in billing, metering, and office staff across utilities. Although energy utilities
are restricted by the U.S. Public Utility Holding Company Act to refrain from expansion into other
sectors, this Act may be repealed. If this happens, cross-utility endeavors are clearly possible. In
1998 New Jersey’s Public Service Electric and Gas Company announced that its nonregulated
subsidiary, Energis Resources, would partner with United Water Resource (Seidenstat et al., 2000).
The majority of private water utilities are subject to regulation by state public utility commissions
and a traditional rate-of-return regulation. As of 1995, state commissions regulated roughly 8,537
water utilities (Beecher et al., 1995). Four states and the District of Columbia do not oversee water
utilities due to the small number of privately-owned utilities in these areas. Many larger, publicly-owned
utilities are not regulated except for certain issues such as selling water outside of their system.
The scope of regulation by public utility commissions varies and could include any of the
following: approval of loans, mergers, service areas, acquisitions; oversight of management; review or
audit of drought management practices and accounting; and setting of the rate of return. State
regulatory commissions and local agencies have traditionally engaged water utilities in protracted rate-
setting cases and have favored average cost-pricing schemes. Tight controls over rate-setting originally
arose because of concerns about monopoly pricing power but, as pointed out above, these concerns
may no longer be appropriate. The result has been a lack of flexibility in pricing water and a general
decline in water systems. “Traditional rate-setting methods, employed by state regulatory commissions
as well as local government agencies, appear to have produced a situation of rapidly deteriorating water
systems, both rural and urban, characterized by aging capital facilities and under-maintained water
systems” (Mann, 1981, p. 101). An interest in reducing these price subsidies and additional unfunded
mandates under the SDWA have rendered these regulatory issues more serious and increased interest
in privatization.
4.13 Water Markets
Given the dry conditions and rapid growth in the western half of the United States, it is not
surprising to find water market activity concentrated in the U.S. west. During dry years, most of the
river basins in the southwestern U.S. have water demands that exceed supply, e.g., the lower Colorado
and the Rio Grande. In the drier areas water markets have played an increasing role in balancing water
supply and demand over the past 25 years. The California State Water Bank is a good example of
how water trading has helped prevent serious economic damage that could have occurred during the
1990s drought (Easter et al., 1998).
Water markets can be used to deal with supply and demand variabilities as well as with overall
growth or shifts in demand. Short-term or temporary transfers are best suited for managing supply and
demand variability while permanent or long-term transfers are more suitable for handling increases or
shifts in demand. California’s water trading has been best suited to deal with supply and demand
variability, because most of the water trading has been short-term in nature.
Hundreds of thousands of acre-feet (1 ac. ft. = 1,233m3) of water are transferred annually in
California but most of the transfers are for less than one year. These temporary trades occur mostly in
the same irrigation district or system. Long-term trades have been limited to about 25 in the last 20
years and are mostly in response to urban demands. For example, in 1989 the Los Angeles
Metropolitan District (MWD) obtained 106,000 ac. ft. from the Imperial Irrigation District (IID) while
in 1998 the San Diego County Water Authority obtained 200,000 ac. ft. from IID. Most of this water
will come from water conservation within IID’s irrigation system (e.g., canal lining) and conservation by
In 1998 California’s Department of Water Resource reviewed 23 transfer proposals that would
use State Water Project facilities (Table 4). This, of course, leaves out the transfers that occur within
districts or would be transferred in other facilities. Still the total proposed transfers in State Water
Project facilities amounted to 362,102 ac. ft. in a year of relatively good rainfall. Over 44 percent of
the transfers were from urban to urban while another 27 percent were from agriculture to agriculture.
The emphasis on temporary or short-term transfers in California is somewhat different from
trades in Colorado, New Mexico, and Utah where many more permanent trades took place.
MacDonnell (1990) reported that these states had 5,844 permanent water transfers during 1975-1984.
Not surprisingly, the direction of these trades has been primarily from agriculture to urban users since
Western agriculture receives nearly 85 percent of all water diversions (Howe, 1998). There have also
been numerous temporary trades within the Western states but a trend towards more permanent trades
is likely to occur because of the shifts in demand to urban uses which require a more assured water
supply than irrigation. Agricultural water use peaked in the 1980s while urban use has continued to
expand (Gleick, 1998). The shift to more permanent trades would be facilitated by institutional
arrangements that help clarify water rights and streamline the procedures for determining if there will be
adverse affects on other water users. Howe (1998) points out that one reason Utah and New Mexico
had the most permanent water transfers is because they both have a clear, nonlegalistic means of
determining if there will be any adverse affects on other water users caused by proposed transfers.
Once the assessment of potential adverse effects has been completed the proposal is approved or
modified by the Office of the State Engineer. Court appeals occurred in only about one percent of the
The shift towards more permanent transfers is evident in the 1998 data. Thirteen western states
reported 140 separate water transactions in 1998. They included 104 transfers for municipal purposes,
24 for irrigation and 12 for public trust purposes. Most of the sales were by agricultural users. Of the
total, 102 were purchases of water rights while the remaining 38 were short-term leases or exchanges.
Because of good rainfall in the western U.S., 1998 was a low year for water trades. The number of
unit transactions involving the Colorado-Big Thompson illustrates this point. In 1998, 3,187 units were
traded as compared to 6,426 units (a record) in 1997 and 5,167 units in 1996 (one unit equals an
average annual yield of 0.7 acre-feet).
California is also likely to experience an increase in longer-term trading. Many farmers are
beginning to find that they can make more money selling water to urban areas than growing crops.
Cities are willing to buy the water but they will usually want a long-term commitment and even
permanent trades. If this trend accelerates, it could have major implications for agriculture and
communities in the southern half of California’s large San Joaquin Valley. This is the area where some
of the world’s largest corporate farms are located and sales of water could reduce agricultural activity
in this part of the valley.
4.2 The European Union
Like U.S. state policies, country policies in the European Union have provided the guidelines
for their privatization of the water sector and development of water markets. An important question is
how will this change in the future as the concerns for water quality grow and more areas find it difficult
to obtain low cost clean water supplies? The growing concern about water quality combined with the
fact that most of the rivers in Europe are international, seems to suggest that European Union directives
will become increasingly important in future privatization and water markets in Europe. Yet there is still
a strong sentiment in favor of local control over resources particularly in Northern Europe. This creates
a growing dilemma in water resources management: the desire for local management over a resource
whose’s use has many international repercussions that require a broad management prospective.
4.2.1 The Community Water Policy
European water policy began in the 1970’s, with environmental standards for surface waters
used for potable water supplies, and later on, by setting binding quality targets for drinking water and
by addressing other water resources and water uses (fish and shellfish habitat, recreation, and
groundwater). While some directives have proved to be quite effective, other pieces of European
legislation--such as the Nitrate Directive addressing pollution from agricultural sources--have been
poorly implemented by member countries. According to a recent EC Commission’ communication on
the state of Europe’s environment, while there have been substantial improvements in surface water
quality due to reductions in point source discharges, such as emissions of phosphorous and organic
matter, pollutant emissions from diffuse or nonpoint sources have shown little change. EU maximum
groundwater concentrations of nitrate and certain pesticides are frequently exceeded (European
Commission, 1999).
By the mid 1990s, pressure emerged for a substantial redirection towards adopting a more
global approach to the Community water policy, by integrating disperse pieces of legislation as well as
by adding new objectives. In response to a request by the European Parliament’s Environment
Committee and from the Council of Environment Ministers, in 1997 the European Commission
produced its proposal for a Water Framework Directive (COM(97)49), subsequently amended
(COM(97)614, COM(98)76, COM(99)271). Currently it is being negotiated by the European
Parliament and the Council of Ministers and the final adoption is foreseen for 2000.
The draft directive which, inter alia, would be the first piece of European legislation to address
the issue of water quantity, is aimed at: (a) streamlining Community water legislation, (b) expanding the
scope of water protection and achieving a “good status”12 for all waters by a certain deadline (2010),
(c) promoting in all member countries the adoption of single system of water management, namely
management by river basin, instead of according to administrative or political boundaries; (d) increasing
awareness of citizens and getting them more closely involved; (e) ensuring that the price charged to
water users is based on the full costs of water.
The introduction of pricing oriented to full-cost recovery is undoubtedly one of the most
important European water policy innovations (Blöck, 1999) and has been one of the most controversial
component of the Commission’s proposal. Whereas this principle has a long tradition in some
countries, this is not the case in many countries, where, in general, the recovery rates vary considerably
between water use(r)s and economic sectors. According to the draft Directive, “by 2010 Member
states shall ensure full cost recovery for all costs for services provided for water uses overall and by
economic sectors.” However, while full-cost recovery appears to convey a clear-cut criterion, when
one considers how the concept is actually practiced, significant differences are found (OECD, 1999a).
For instance, there are countries where the principle is translated into recovery of operation and
maintenance (O&M) costs, in others into recovery of O&M and capital costs, while in other countries
there is an effort to include scarcity values and negative externalities caused by water users.
In this respect, the draft directive does not provide an unambiguous and clear-cut operational
translation of the full-cost principle and tends to leave some freedom to member states. However,
“while the European Commission has set up modest objectives with regards to cost recovery, it has not
ruled out the incorporation of scarcity values and environmental externalities in full cost recovery”
(OECD, 1999a, p. 35). According to the Commission’s proposal, the principle of full-cost recovery
must be applied to all sectors, and cross-subsidization between sectors should be avoided. Member
countries are allowed to grant exemptions, e.g., for providing basic services to households at an
affordable price or for regions entitled to structural fund support, but all deviations from full-cost
recovery prices should be explicit.
Besides European legislation directly addressing water issues, member states’ management and
operation of water services have also been indirectly affected by other policy developments at the
European level. These developments include the legal requirement to integrate environmental protection
into other EC policies, a principle which was established by the Single European Act and was given a
more comprehensive legal basis in the Maastricht Treaty. A second indirect driving force has been the
process towards the European Monetary Union which has imposed on member countries a more
rigorous budget discipline in order to cut government deficits and public debts. A third force is the
process of introducing more competitive pressure in the European utility markets traditionally dominated
by publicly owned monopolistic companies.
4.2.2 Member Countries
European legislation has exerted an external pressure and has contributed to a slight reduction
in the heterogeneity of national environmental policies. Nevertheless, partly because of the lack of a
global and comprehensive community water policy, significant differences remain between member
countries regarding their legal and institutional arrangements, organization and management of water
services, and pricing principles. Yet a comprehensive overview of these national water policies goes
beyond the scope of this paper. Instead we will focus on some significant features and developments
involving privatization, water markets, and water pricing.
Increasing regulation of water uses
In member states there has been an increase in the regulatory power of public authorities over
water use. Generally speaking, increasing state regulation and centralized water management has been
a common feature in southern countries, while involvement of local authorities has remained a typical
feature of the institutional design in northern ones (Barraqué, 1998).
Contrary to countries which have embarked on a process of privatization of water rights, and
establishing water markets, in Europe, although water markets are gaining interest, only Spain has
recently taken steps in this direction.2 In fact, there has been a tendency towards increasing the share
of public waters, by subjecting water uses (abstractions and wastewater disposal) to licensing. Even
groundwater is being included in this evolution to public waters. Recent reforms adopted in member
states such as Spain and Italy, where groundwater abstractions were de facto traditionally considered
as part of landowner rights, all water resources, including groundwaters, have been formally placed in
the public domain.
Water pricing
European water users face significantly different prices. Observable variations in service
charges are only partly traceable back to differences in natural resources endowments, accessibility to
sources, patterns of urbanization, or efficiency levels in the provision of water services. In fact, inter
and intra-country price heterogeneity is mostly explained by differences in national and local water
policies, and patterns of operation of water services, involving heterogeneous pricing structures and
cost recovery rates.
Agricultural water pricing principles vary considerably within the European Union. While
there are countries where farmers do not receive any special treatment, such as The Netherlands,
England and Wales (OECD, 1999a), in general European farmers enjoy a privileged status, and are
charged less than other water users. Capital costs for supplying irrigation water are usually covered
through public budgets. In countries like Greece and Italy, water charges for agriculture are often
insufficient to generate enough revenue to cover operation and maintenance costs.
In other countries which have experienced increasing competition between agricultural and
other water uses, a tendency towards increasing farmers’ contributions is gradually emerging. For
example, France and Portugal, although maintaining a special status for agricultural water users, have
made progress towards matching water charges and supply costs. Also in Spain, despite the
administrative problems encountered in implementing the 1985 Water Law (which inter alia has
introduced a levy intended to cover capital investments), there are many examples of collective and
private efforts to use irrigation water more efficiently. In Italy, an innovative program is being
implemented in the southern Capitanata region (one of the country’s most important irrigated areas)
with the aim of increasing cost recovery, introducing water-saving farming practices, and penalizing
excessive consumption (OECD, 1999a).
Even household water pricing varies considerably among countries (Table 5), and often within
the same country. In Italy, where in 1998 the average price was less than IT 800 lire per cubic meter
as compared to 3,600 lire in Berlin (Lobina and Hall, 1999), the range of price variation for water
supply and sewerage services is 1 to 10 or more (Massarutto, 1999). In general, although not
exclusively, in Southern countries, households have benefitted from various measures aimed at
tempering the industrial cost recovery rates for water services. This objective has been pursued
through different mechanisms, such as public financing for infrastructural development, free use or
“political” pricing for the operation of public water networks, or cross-subsidization among different
utilities at the municipal or intermunicipal level.
However, the general trend observable in Europe is towards an increase of cost recovery rates.
This process will become mandatory in all Member states if the EC Water Framework Directive is
approved. Even without the directive, cost recoveries are gradually increasing even in countries such as
Italy where support for subsidizing water users has been traditionally stronger than in other countries
(Massarutto, 1999). The 1994 Italian Water Law (36/1994) provides a new framework for water
supply and sewerage through vertical integration of the water cycle (abstraction+ sewerage + treatment
+ discharge) into single territorial units (ambiti territoriali ottimali). In principle, the units should be
defined according to river-basin criteria. The national act foresees a single system of water charges for
the entire water cycle where prices have to be set so as to generate enough revenue to cover
investment and operating costs. Tuscany, one of the most advanced regions in implementing Law
36/1999, has identified investment plans and proposed new charges in each territorial unit. In general,
the process has been slow and on average, an increase of water charge of 35% is foreseen over the
next 20 years in Tuscany (Il Sole 24 Ore).
Other European countries, either at the national or local levels, have conducted or are
conducting household pricing reforms, aimed at integrating traditional social considerations with the
objectives of using water more efficiently and treating it as an economic good. In Spain, the city of
Barcelona has pioneered the use of prices designed to combine strong incentives to save water with
equity considerations. In France, the 1992 Water Law prohibited the use of “flat fees” thereby ruling
out both nonvolumetric schemes and prices combining a fixed charge with volumetric charging. For
Portugal, Decree-Laws 379/93 and 319/94 prescribed that charges for privatized water services must
be fixed at economic levels. Finally, Denmark’s 1996 government declaration requires water utilities to
ensure that all properties connected to public water supply have meters installed (OECD, 1999b).
Restructuring and privatization of water services
Private companies’ contribution to the provision of water services varies considerably between
member states. For water supply, in 1996 the private contribution ranged between about 90% in
England and Wales to almost nothing in Denmark, Greece, Ireland, Luxembourg, The Netherlands, and
Austria (Hall, 1997a). Generally speaking, there is an increasing involvement of private companies in
service provision, although this takes different forms. Full privatization has only occurred in England
and Wales, while delegation (concessions), traditionally dominant in France, is increasing rapidly in
Spain and Portugal (OECD, 1999b).
Primarily water utilities in France are publicly owned, but 75% of the population is served by
private companies working under operation and maintenance contracts (Seidenstat et al., 2000).
Privatization in France has principally involved either concessions to construct and operate facilities or
affermage whereby the municipality bears the initial expense of construction and the private firm takes
over operation. Affermage is often chosen when the municipality can receive preferential interest rates.
The price of water is often set by a contracted formula which may include a surcharge which the
operator returns to the city as debt service. As a result of this system, the French water utility industry
is characterized by multiple large and influential companies known for technological innovation and high-
quality service delivery.
Private concessions have also appeared in Italy (the municipality of Arezzo has recently
awarded a concession to a consortium headed by Lyonnaise des Eaux). However, the dominant
process appears to be corporatization (sometimes associated with partial privatization through sale of
equity) of municipally owned firms (aziende municipalizzate) which are starting to operate beyond
their own traditional territories. In Germany, where like Italy, the water sector has been dominated by
municipally owned firms (Stadtwerke), in 1999 the sale of 49.9% equity in Berlin’s water company
was announced. In addition, the city of Bremen has partially privatized its sewerage company (Hall,
One of the important reasons why countries are exploring economic approaches to water
resources management is the potential economic and environmental benefits from doing so.
Privatization and water markets both have the potential for establishing user incentives for efficient
water use. This can reduce the need for expensive future water development and reduce government
capital expenditures.
To realize these benefits some important institutional changes will be needed. In some cases it
may be a change in tax laws and in others it may involve amending the basic laws regarding the sale of
public assets. For water markets it means changing the rules so that private tradable water rights or
water-use rights are established.
However, in developing the condition for privatization of water service or for establishing water
markets it is important to guard against possible market failures. In water markets it is important to
develop a nonlegalistic means for making sure that water trades don’t have significant third-party
effects. For privatization, regulation may be needed to prevent entities from taking advantage of their
monopoly control over either the water supply or the distribution network. Clearly second-best issues
arise if significant third-party impacts occur because of water trades or monopoly control over the
distribution system are ignored.
Another related question is the trade-off between improving the efficiency of water use and
equity concerns. In some cases this can be addressed with a two-price system where domestic users
buy enough water to meet their “basic needs” at a relatively low price but pay a much higher price for
any water in excess of this basic need. In many developing countries low water prices that are intended
to help the poor really do not help because the poor do not receive public water services. In fact, low
water prices imply poor service, and the group that suffers the most from poor service is often the poor.
There are no unique answers to dealing with problems of water scarcity. What works in a
community facing “real” water scarcity will be different from one where the problem is inadequate
institution’s and/or management. Thus problem identification and designing solutions in relationship to
existing institutions are important in dealing with water issues.
The comparison of U.S. and Europe illustrate some interesting differences in their approach to
water scarcity concerns. What explains these differences and what have been the results? The first
question is not easy to answer but it may be associated with the relative importance of the domestic
water supply relative to irrigation. Where irrigation is important, it is the largest user of water.
Consequently, when water scarcity and the need for change hit Chile, Mexico, and California in the
United States--where irrigation is important--they made use of markets to improve water-use efficiency
and save water. In contrast, when England decided to privatize public water entities, it was in response
not so much to water scarcity but to a government budget scarcity and the need for future water
infrastructure investments. Privatizing water entities took them out of the public sector budget. In
addition, it allowed the government to make the monopoly provision of water contestable where
different firms could compete periodically to operate or manage a water system under a long-term
In Europe, only Spain has shown some interest in water markets. One reason for this may be
an emphasis on the basic right-to-water as opposed to water as an economic good. Another reason
for the difference in approach could be the difference in past institutional arrangements. For some
countries, past institutional arrangements may have lowered the transaction cost of making new
institutional changes. For example, the western United States and Chile both had some experience with
establishing tradable water rights.
There are some similarities between Europe and the U.S. in that both have a relative abundance
of fresh water from a global perspective. Yet at the regional level there are areas that are facing serious
shortages, at least, in some years. Many times the shortage is due to inadequate institutions or water
management rather than an absolute scarcity.
A further similarity is their approach to water policy. Both lack a comprehensive federal water
policy, especially for water quantity. The one exception to this is that both Europe and the U.S. seem
to be moving towards a comprehensive policy for water quality at least for point sources of surface
water pollution.
Another interesting similarity between the European and U.S. approach to water resources
issues is their failure to effectively address groundwater and nonpoint pollution problems. These are
clearly difficult problems to solve and none of the countries has devised an innovative means to
approach either issue. For example, Italy’s and Spain’s approach of putting groundwater in the public
domain could be a step backward because without effective enforcement, it will likely provide the
current users an incentive to pump the groundwater even more rapidly. Passing laws is one thing,
enforcing them is quite another.
Nonpoint pollution has some of the same monitoring and control problems as groundwater.
Since pumpers as well as the nonpoint polluters are widespread and numerous, they are difficult to
monitor and control. This means that institutions need to be created that change the incentives and
allow more local monitoring and control. Can we create local pumping districts that set pumping rates
for their aquifer? For nonpoint pollution a targeting of conservation practices and monitoring of critical
areas might work. Another possibility for some areas may be to develop markets for pollution permits
that will allow point sources to buy permits from nonpoint sources. This would in essence have the
point source help pay for practices that reduce nonpoint pollution. Both U.S. and European countries
need to try new approaches, such as those mentioned above, to address their critical water policy
*An earlier version of the paper was presented at the 2nd International Symposium of Water
UNITWIN-UNESECO, Cannes (France), May 20-31, 2000, and at the 7th Joint Conference on
Food, Agriculture and Environment, Universities of Bologna, Minnesota and Padova, Bologna (Italy),
12-14 June 2000.
**The authors would like to thank Alberto Garrido for providing information about the recent
Spanish provisions about water markets, and Tracy Boyer for her help in putting together material for
the U.S. section of the paper and in editing the paper.
1Following Brouwer and Falkenmark (1989), renewable freshwater available in a country (TR)
is defined as the total amount moving in rivers or aquifers; TR may be divided into the amount
originating from “domestic” rainfall or by water received from neighboring countries in transboundary
rivers and aquifers. According to the Falkenmark’s water stress index, while a country with more
than 1,700 cubic meters/year/person is expected to experience only intermittent and localized water
shortages, the threshold of 1,000 cubic meters has been proposed as an approximate benchmark
below which a country is likely to experience widespread and chronic shortfalls; at less than 500 cubic
meters per capita, water availability becomes a primary constraint on socio-economic development.
2Water for basic human requirements would have almost a completely inelastic demand.
3The Spanish Government submitted in May 1999 Bill to the Parliament with the intention to
reform the 1985 Water Law. Among the bill’s breakthrough changes is the possibility of water rights
holders to sell or lease-out their rights. The bill attempts to promote water markets, thus facilitating
trading among right-holders or water claimants, although the priority allocation rules established by the
1985 Law will still remain in force (Garrido et al., 1999).
4The term water services includes water abstraction, treatment and distribution, as well as
interception and treatment of waste waters (sewage and sanitation systems). Although many
considerations also apply to the latter, in this paragraph we will mainly consider freshwater supply.
5For example, in France, local governments have imposed an “entry fee” for water concessions,
and successful bidders have then been able to increase water charge to cover the fee; in Spain, the
successful company pays an annual rent which can be transferred to water charges (Hall, 1997a); the
water concession in Budapest was awarded to the private bidder offering the greatest financial benefit
for the municipality, although it involved a higher price for consumers (Hall, 1997b).
6In some areas the available water distribution network may be so inefficient or provide such a
poor service that the construction of a competing network could be economically feasible (Webb and
Ehrhardt, 1998).
7The only economically feasible competitive distribution networks are bottled water distribution
systems, which are a minor (typically, a complementary) component of the whole water distribution
system. 8The concept of “inset appointment” was introduced by the Water Act 1989. A new company
can apply for an appointment to supply water (or sewerage) to customers located in a defined area.
Originally (until the Act was amended in 1992), the only customers eligible for inset supply were new
customers, i.e. sites that were not already connected and that were more than 30 meters from the local
water utility’s distribution main (or sewer).
9In France there are three types of “concessions”. For instance, a private company may: (i)
either acquire the complete responsibility for operating the water system, making the necessary
investments in the infrastructure, and take responsibility for financing them at its own risk (concession in
the strict sense, “concession” in French), or (ii) operate the business and carry on maintenance at its
own risk, but a public authority is responsible for investments (operating concession, “affirmage” in
French), or (iii) receive a flat fee to manage the system, without taking any responsibility for investments
(management contracts, “gérance” in French) (Hall, 1997b).
10Added by the authors.
11Historically, private provision of water services was the norm through the early to mid 1800s,
but by the 20th century, municipal monopolies comprised roughly half of the water works in the U.S.
(Baker, 1899). Today, ownership of water services varies by size of the community served, with
private ownership predominating only in communities serving less than 500 individuals. The EPA
estimates that while 33% of community water systems are privately owned, only 15% of all people are
served by privately-owned companies (USEPA, 1999). Most large water systems are municipally
owned and provide safe drinking water at affordable cost.
12The terms “good status” come directly from the EC directive and appear to mean water
quality consistent with EC water quality standards.
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Table 1. Characteristics of Public and Private Goods, Market Power, and Externalities in Water Sector Services
Nature of the good Competition,
Type of System Rivalry Excludability contestability Externalities Comment
Wastewater treatment LHLPH, WP Public good characteristics
Water supply
Piped water
Trunk system (intake pumping
station) HaHLGD Private good characteristics
Distribution system LMLPublic good characteristics
Terminal system MH H Private good characteristics
Village wells MLHSF, public good characteristics
Markets (bottled water) H H H Private good available world-wide
Surface water
Trunk system (dam, main canal) MbMLWL, E Public good characteristics
Distribution system (secondary
and tertiary canal) MbM M WL Public good characteristics
Terminal system (on farm) H H HcWL, S Private good
Deep tubewells
Pumping facilities HaHMGD Private good using open access
Distribution system M M M WL, S Public good characteristics
Terminal system H H HcWL, S Private good
Shallow tubewells HaH HcWL, S Private good using open access
Run of the river systems
Headworks MbM M Public good characteristics
Distribution system MbM M WL, S Public good characteristics
Terminal system H H HcWL, S Private good
Small dams and reservoirs
Headworks MbM M Public good characteristics
Distribution system MbM M WL, S Public good characteristics
Terminal system H H HcWL, S Private good
Markets H H MGD Limited by TC
Flood control structures L L L PH Public good
Hydropower generation MH H Private good
Instream uses
Amenity uses L L MPublic good
Access for fishing and recreation M M M WP Can be open access resource
Piers and locks MH H WP Toll good characteristics
River channel LMHWP Could be toll good or public good
Note: PH, public health; WL, water logging; WP, water pollution; GD, groundwater depletion; SF, difficult to exclude users due to social factors; S,
salinization; E, erosion during construction and because of migration into the area; L, low; M, medium; H, high; TC, transaction costs for trades
beyond the tertiary canal due to the lack of property rights and infrastructure.
a. The degree of rivalry associated with a given well actually depends on the nature of the aquifer from which the well is drawing. High water
resource scarcity is assumed.
b. The degree of rivalry depends on the scarcity of water and the capacity of the canal.
c. Function is usually performed by private farmers.
Adapted from: World Bank, 1993, Appendix A, pp. 86-88.
Table 2. Market Conditions and Public Policy for Efficient Provision and Management of Water
Type of Good
or Condition Definition and Provision
Public goods These are goods that are nonrival in consumption (use) and it is
very expensive to exclude users. Full or majority public
ownership and public capital financing may be needed to ensure
adequate allocation of resources. Where feasible and desirable,
rights should be granted to private sector or water user
organizations to operate publicly owned facilities under regulation
and contract. Otherwise, the public sector should produce the
service, such as flood control and large multipurpose dams.
Toll goods Toll goods are nonrival but users can be excluded at a relatively
low cost. If there are concerns with equitable access to users,
market power, scarcity of substitutes, or optimal provision of the
good or service, public regulation will be needed regarding
property rights, conditions of competition, and quality and pricing
of services. When the services are strongly nonrival, some public
financing mechanism (for example, through benefit taxes such as
land taxes) might be necessary to supplement direct user charges.
Conventional sewerage and navigation are good examples of toll
Open access goods These goods are rival but the cost of exclusion is high.
Regulation is needed to grant limited property rights (rights to
exploit resources or generate services from facilities). Since
nonpayers cannot be excluded, provision may require some
indirect financing through a budgetary mechanism. Regulations
are also needed if use of a resource such as groundwater can
destroy its future usefulness (for example, salt water intrusion and
aquifer compaction) or cause well interference.
Monopoly power Monopoly potential can be high in the provision of water services
because of the decreasing cost nature of the sector. Policies and
regulations should remove barriers to entry and competition (for
example, allow access to capital), promote contestability (for
example, contract out the operations of water supply systems, the
maintenance of irrigation canals, or the collection of water fees),
and facilitate development of substitute services. If minimum
investment requirements are very large (economies of scale),
some public investment or public capital
financing may be needed, which is likely to be the case for large
dams and canal systems. For the remaining cases of natural
monopoly, regulation of pricing is needed (for example, water
Externalities Externalities (technical) occur when an entity A’s utility or
production relationship includes (nonmonetary) variables whose
values are chosen by others without any attention to their impact
on or concerns of entity A. The impact is unintended and the
perpetrator is not compensated. Regulation of investment (for
example, land use zoning) and technical standards for operations
(for example, the level of pollutants that a municipal waste
treatment plant is allowed to release into a river) may be needed.
Alternatively, changes in private incentives, through fees, permits,
or subsidies, can correct for externalities. The larger the
externalities (positive or negative) are, the more justified is public
involvement in regulation, changing incentives, and provision (for
example, building wastewater treatment plants).
Asymmetric information The lack of information or asymmetric information can cause a
misallocation of water resources among users as well as types of
uses. Water users generally have information about their water
needs and deliveries that the system managers may not have. In
contrast the system managers may have information about likely
supplies that the users do no have. Decentralization of water
investment and management decisions has been one of the
effective methods for dealing with asymmetric information
problems. New technology is also likely to reduce the transaction
cost of obtaining information and, therefore, improve manager’s
ability to effectively allocate water resources and improve
investment decisions.
Adapted from: World Bank, 1993, Appendix A, pp. 89-91.
Table 3. Privatization Options Found in the United States
Options for Private
Sector Description
Acquisition Public utility sells the facility to private entity resulting in private
ownership and operation.
Joint venture Private entity owns facility in conjunction with public utility
Design, build, own, operate
and transfer Private entity builds, owns, and operates the facility. At the end of the
specified period, such as 30 years, the facility may be transferred to a
public utility.
Concessions to design,
build and operate Private entity designs, constructs, and operates the facility. The public
utility retains ownership and financing risk, while the private entity
assumes the performance risk for minimum levels of service and/or
O & M concessions Public utility contracts with private entity for a fee to operate and
maintain the facility. The public utility owns the facility.
Concessions to design
and /or build Private entity designs and/or constructs the facilities and turns it over
to the public utility to operate.
Contract for specific
services Private entity contracts to provide public utility with specific services
such as meter reading or billing and collection.
Management concessions Private entity manages and supervises the public utilities personnel.
Source: Adapted from Beecher et al., 1995.
Table 4. Water Transfers Using State Water Project Facilities 1998
Type of Transfers Number of Transfers Amount of Water Conveyed
For Agricultural Use
Agriculture to Agriculture 11 99,026 acre-feet
Agriculture/Urban to
Agriculture 1 85,700
Urban to Agriculture 1 100
Subtotals 13 184,826
For Urban Use
Urban to Urban 4 159,701
Agriculture to Urban 4 2,494
Subtotals 8 162,195
For Environmental Use 2 15,081
Totals 23 362,102 acre-feet
Source:Department of Water Resources, 1999.
Table 5. Average Pricing (m3) for Household Water Services (water supply+wastewater services) in
European Countries (Germany = 100)
Austria 19
Belgium (Flanders) 67
Belgium (Brussels) 51
Danemark 74
Finland 64
France 73
Germany 100
Greece 27
Italy 20
Luxembourg 24
The Netherlands 74
Spain 25
Sweden 68
England and Wales 73
Scotland 34
Source: Massarutto, 1999.
... In the bank, all exchanges and the number of shares of the water right holders are known and every market information, is updated. The bank plays an important role in encouraging the private sector to invest in water supply and conservation projects and can communicate between water applicants and investors (Dosi and Easter, 2000). ...
Increasingly, water scarcity is a major global challenge. Ongoing water shortages have attracted policy makers’ attention, to endeavor have more effective water resource allocation methods to balance between human needs and protecting natural capital (e.g. riverine ecosystems and riparian areas). This situation has changed water management and policy and to focus more on existing water supplies and toward demand management. Some of these measures include economic tools, such as water markets, voluntary agreements, and the establishment of water banks. Water banking is an institutional arrangement for managing a system of deposits and withdrawals that is specifically designed to facilitate water transfer among different users. The common goal of a water bank is moving water from lower-valued to higher valued uses. Combined with an active water market, the water bank serve as the intermediary that matches buyers to sellers via a set of rules, including information on price, volume of water, etc. The most important opportunity is to facilitate long-term flexibility to increase water security. Water banking to solve water-related issues by reallocating water, whether within or across catchments can help provide water resources to high-valued uses in emergencies and droughts. Thus, a well-functioning water bank can help improve water governance and management. This chapter examines the structure of water banks and the conditions for their establishment and provides several examples of water banks across the world.
... Municipal benefits range from $5000 to $17,000 per 1000 m 3 NB: CWA=central water authority; WUA=water user association. 1991; Sampath, 1992); costs also include environmental externalities (Biswas, 1997); 6 and costs may need to account for future supply scarcity (Dosi & Easter, 2000). 7 In addition, marginal cost pricing ignores equity concerns (Seagraves & Easter, 1983;Tsur & Dinar, 1997). ...
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As globalization links economies, the value of a country's irrigation water becomes increasingly sensitive to competitive forces in world markets. Water policy at the national and regional levels will need to accommodate these forces or water is likely to become undervalued. The inefficient use of this resource will lessen a country's comparative advantage in world markets and slow its transition to higher incomes, particularly in rural households. While professionals widely agree on what constitutes sound water resource management, they have not yet reached a consensus on the best ways of implementing policies. Policymakers have considered pricing water - a debated intervention - in many variations. Setting the price 'right,' some say, may guide different types of users in efficient water use by sending a signal about the value of this resource. Aside from efficiency, itself an important policy objective, equity, accessibility, and implementation costs associated with the right pricing must be considered. Focusing on the examples of China, Mexico, Morocco, South Africa, and Turkey, Pricing Irrigation Water provides a clear methodology for studying farm-level demand for irrigation water. This book is the first to link the macroeconomics of policies affecting trade to the microeconomics of water demand for irrigation and, in the case of Morocco, to link these forces to the creation of a water user-rights market. This type of market reform, the contributors argue, will result in growing economic benefits to both rural and urban households.
... At the same time, these methodologies do not fully account for a number of policy issues that are in the focus of water pricing literature. See Dinar and Subramanian [1997], Dosi and Easter [2000], Johansson et al. [2002], and Tsur et al. [2002] for recent reviews of water policy and pricing issues. In particular, water pricing may imply water measurement and monitoring, tax distortion or transaction costs linked to tax collection. ...
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The legal framework in the EU is faced today with the new water framework directive (WFD) (60/2000) that sets up new criteria for water management, regulation, and pricing. The aim of this paper is to analyze the problem of water regulation in agriculture in connection to the WFD. This is done by setting up and testing a simulation model based on the integration of a mathematical programming model at farm level and an optimal regulation model at the level of irrigation boards. The model allows quantifying water demand and optimal regulation from the policy maker's point of view. When implementing both full cost recovery and the polluter pays principle, the results show likely major impacts of water pricing on farm income and employment. The optimal policy is a combination of pricing instruments related at the same time to crop mix, water consumption, and pollution. Transaction costs connected to policy implementation have to be weighted against the incentive benefits of volumetric pricing. Altogether, economic, social, and environmental issues have to be carefully considered in order to design suitable water policies.
... Municipal benefits range from $5000 to $17,000 per 1000 m 3 NB: CWA=central water authority; WUA=water user association. 1991; Sampath, 1992); costs also include environmental externalities (Biswas, 1997); 6 and costs may need to account for future supply scarcity (Dosi & Easter, 2000). 7 In addition, marginal cost pricing ignores equity concerns (Seagraves & Easter, 1983;Tsur & Dinar, 1997). ...
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Increasing economic pressures on water resources are causing countries to (re)consider various mechanisms to improve water use efficiency. This is especially true for irrigation agriculture, a major consumer of water. ‘‘Getting prices right’’ is seen as one way to allocate water, but how to accomplish this remains a debatable issue. Methods of allocating water are sensitive to physical, social, institutional and political settings, making it necessary to design allocation mechanisms accordingly. This paper surveys current and past views on allocating irrigation water with a focus on efficiency, equity, water institutions, and the political economy of water allocation.
In this chapter we examine how water governance and demand management arrangements can be linked to economic instruments, such as water markets, to address the broad range of water reallocation problems that exist in many global contexts. The utilization of economic instruments is context-specific throughout the world and can take many forms. This chapter therefore lists the pros and cons of some more common instruments. While successfully combining regulatory and economic instruments is far from straightforward, policy-makers can learn from growing evidence of successful partnerships between these two approaches. It may be costly both in terms of political support and transaction investments to strip away existing arrangements in favour of more flexible and better-suited institutions to manage scarce water resources. However, it would be expected that ignoring the problems, and hoping they will resolve themselves, would be more harmful to private and public welfare outcomes in the long run.
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Summary The paper presents the results of the EU funded Project called WADI - Sustainability of European Irrigated Agriculture under Water Directive and Agenda 2000, V RTD programme, European Union (2001-2003) limited to the Italian experience. The objective of the project is to evaluate the economic, social and environmental sustainability of European irrigated farming under different scenarios concerning water policy and the Common Agricultural Policy (CAP). The methodology relies on the combination of scenario analysis and the modelling of irrigated farming systems. Multicriteria farm models, integrating socio-economic aspects with agronomics and hydraulics considerations are solved using mathematical programming techniques. The simulation allows to evaluate the consequences of different CAP and water policies on irrigated agricultural systems. The methodology is applied to five study areas in Italy. Policy scenarios and farming systems show a very different behaviour in relation to water policies. CAP and water policy objectives appear somehow in contrast and should be mediated in a common policy design framework in order to avoid undesired social and economic effects and in order to guarantee policy effectiveness and efficiency. WFD identifies in the basin plan the instruments to use and request a participative approach for their implementation. In such process, a stronger support from quantitative analysis and simulation could play an important role to design more socially sound local policies. The development of proper tools favouring the methodology transfer represents therefore a priority in future research agenda.
Der vorliegende Beitrag diskutiert die optimale Organisation der Wasserversorgung unter Berücksichtigung der grundlegenden Gutscharakteristika und der spezifischen Produktions-struktur. Nach einer formalen Beschreibung der einzelnen Produktionsstufen und der realen Organisation des Wassersektors in Deutschland werden kurz verschiedene Modelle zur Sek-tororganisation vorgestellt. Anschließend wird versucht, die Bestimmung der ökonomisch optimalen Betriebs- und Angebotsorganisation zu erläutern. Schließlich werden zentrale öko-nomische Konzepte der Produktionsanalyse und der industriellen Organisation für eine empi-rische Überprüfung am Beispiel der Wasserversorgung beispielhaft modelliert. Es zeigt sich, dass empirisch fundierte Organisationsmodelle bisher keinen Eingang in die aktuelle Liberali-sierungsdiskussion in den Wassersektoren gefunden haben. Im Hinblick auf eine Restruktu-rierung der Wasserversorgung in ländlichen Regionen könnte das sog. 'Pool-Modell' eine Al-ternative zur derzeitigen integrierten Verbundlösung darstellen. E N G L I S H V E R S I O N: This paper deals with the optimal organisation of the water supplying industry by having a close look on the basic characteristics of water as a economic good as well as the specific structure of production. After the formal description of the individual stages of production and the real organisation of the German water sector, different models for the sector organisation are briefly being considered. Subsequently, the determination of the optimal firm and industry structure is illustrated from the economic point of view. Finally, central economic concepts with respect to production analysis as well as industrial organisation are modelled for an empirical application to the water supplying industry. It is revealed that empirically based organisation models have not been considered in the course of the ongoing discussion on water sector liberalisation so far. The 'pool-model' seems to be a promising alternative with respect to the restructuring of the water supplying industry in rural areas.
The last decade there has been a growing interest in the idea of “treating water as an economic good”. There is, however, a lot of confusion about the meaning of “treating water as an economic good”. It relates to making the right choices about optimal use and optimal allocation of water among users on the basis of socio-economic trade-off analysis. Insight into the value of water in alternative uses is important for making the right choices. This is different from water pricing, which is an economic instrument that can be used to achieve policy objectives, such as demand management or cost recovery. “Treating water as an economic good” does not automatically mean that water should be allocated by competitive market prices so that the available resource is fully allocated, and allocated to its highest-value uses as is often believed. There are other economic instruments that can be used as well such as tradable water rights, subsidies and block-rate tariffs. Regulatory instruments, such as rationing, and persuasive instruments, such as extension, can also be very cost-effective and suitable. The suitability of instruments depends on the kind of water policy objectives, such as cost recovery, to ensure that supply and demand are brought into equilibrium or to reallocate water from less to more productive uses. Often more instruments are needed simultaneously and preconditions have to be fulfilled. Water is an economic good in the sense that it cannot fully satisfy demand for al its alternative uses simultaneously. Water is, however, also a social good whose availability to certain groups and for certain purposes will serve the greater benefit of society as a whole. Access to clean water is often seen as a basic right of all human beings. It is often considered as too vital to be left to the economic forces of profit- maximisation. Goals other than efficiency, like social equity and sustainability, are often guiding. This explains why the government often subsidises those uses of water that have a high value, but low ability to pay. Economic instruments have a number of advantages. They increase the water use efficiency. Besides, they offer ongoing incentives to reduce usage and to innovate. They are flexible -in the sense that they can be modified and adjusted easily-. Finally, they may generate revenues. In spite of these advantages, economic instruments are not widely applied in water resource management for a number of reasons. Firstly, there might be market imperfections, such as externalities. Secondly, there might be an uncertain relationship between charges and impact on water use. Water prices are often small compared to the value of water. A considerable increase in the price of water is needed to affect demand, which is often socially not desirable. Thirdly, they may not be widely applied because they are new or politically sensitive. Fourthly, transaction costs may be high relative to the size of the efficiency gains. Finally, preconditions for implementation are often not met, such as defined water rights or volumetric measurement. The role of economic instruments to promote a sustainable use and management of water is therefore currently limited. Economics mainly plays a role in the analytical part. Economics provides us with tools that may be useful in resolving competition among alternative uses. The suitability of economic instruments for transboundary water management will be discussed on the basis of a case study. Egypt is mainly served by surface water from the river Nile and Lake Nasser. Egypt currently receives 68 bm3 of surface water per year and uses about 60 bm3, which exceeds the 55.5 bm3 of water ‘agreed’ with Sudan. When Sudan uses all its water entitlements, water supply will decline. Water availability in Egypt will be insufficient considering the high water demand for intensive cropping and plans of the government to expand the irrigated area by 40%. Besides there is a rapid increase in population and water demanding industry. The amount of water assigned to Egypt and Sudan is specified in quantity and time on the basis of rationing. Often this does not allocate water in an economically efficient way. Theoretically water entitlements -which can be considered as a kind of water use rights- can be re-allocated between countries through market mechanisms, i.e. introduce tradable water rights. The marketability of rights encourages users to reduce low value usage and sell surplus water. Such a reallocation is, however, politically sensitive and high transaction costs will be involved
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Water management for irrigation requires suitable policy tools able to meet social objectives and private behaviour. The legal framework in the EU is today faced with the new water framework directive (60/2000), that sets up new criteria for water management, regulation and pricing. Among other things, the water framework directive introduces the principle of full cost recovery and the polluter pays principle for water users. For many areas of Italy, this may be a significant shift compared to present payment criteria, based on traditional rights, political prices, partial running cost coverage or others. The aim of this paper is to analyse the problem of water regulation in agriculture as applied to irrigation issues. This is made by setting up and testing a simulation model based on the integration of a mathematical decision making model at farm level and a principal agent model at the level of irrigation boards. The model allows to quantify water demand and the optimal regulation from the point of view of the policy maker. The results show major impacts of water availability and prices on farm income. The adoption of a mix of pricing instruments related at the same time to crop rotation, water consumption and pollution can significantly improve water policy efficacy.
The European Union is currently thoroughly restructuring its water policy. A proposal by the European Commission for a Water Framework Directive is currently being negotiated at the European Parliament and the Council of Ministers. This legislation will have the following main objectives: • expanding the scope of water protection to all waters, surface waters and groundwater • achieving “good status” for all waters by a certain deadline • water management based on river basins • “combined approach” of emission limit values and quality standards • getting the prices right • getting the citizen involved more closely • streamlining legislation The progress on negotiating the future European water legislation seems to indicate a final adoption in 1999.
The Great Lakes were an open access resource with respect to consumptive water use prior to the promulgation of the Great Lakes Charter and the Water Resource Development Act of 1986. Concern about the open access nature of the lakes was sparked by tne Sporhase v. Nebraska ex rel. Douglas Supreme Court Decision, which limited states' power to prevent water transfers. The resulting nonbinding Great Lakes Charter recommends a set of management rules enforced through state water permits. However, not all Great Lakes States have implemented the Charter Provisions, and damages associated with lake water withdrawals are generally not accounted for by the permits. Because the charter recommends management by a standard (permits enforce some standard) without setting the standard, evolution towards a basin wide transferable permit system is recommended. Transferable permits would require the definition of a standard but would result in a cost effective means of managing the lakes. -Authors
Water availability changes in Europe are discussed in this paper, as seen in a perspective of climatic change. Such changes will be assessed in terms of the shifts in the watering of terrestrial ecosystems, as well as the shifts in the availability in terrestrial freshwater systems. A changing climate will have a major impact on the availability of water. Both wetter and drier conditions will have major implications for societal activities and land use patterns (e.g., agriculture, urban activities, waste water disposal, etc.). Some future research and monitoring activities are proposed by the authors to assess linkages in hydrological shifts to changes in land use patterns.
This article discusses efforts at water pollution control in the United States. A brief overview of the history of federal legislation to control water pollution is presented, along with the Congressional policy of leaving it up to the individual states, the national scope of the water pollution control program, other special and cooperative programs in water pollution control, and future needs for controlling new pollutants.
Part 1 The Analytical Framework: Components of Water Resource Management. Types and Quantities of Water Demand. Types and Quantities of Water Supply. Market Processes for Resource Allocation. Part 2 Interaction of Water Quantity and Quality: Nature of Pollutions and their Specific Impact. Interactions in the Economic-Ecological Systems. Recycling and Reusing Water. Part 3 Instruments in Water Resource Management: Drawbacks of Administrative Controls. Privatizing Water Supply and Distribution. Quality-Discriminant Pricing of Water Services. Water Basin Models. Part 4 Summary and Conclusions: Long-Run Policy Implications in Water Resource Management.