Water Trading and Global Water Scarcity

International Experiences

Josefina Maestu, Josefina Maestu

• Publisher: Routledge
• Year: 2012
• ISBN:
  9781136189791
• Edition: 1
• Topic: Business
• Subtopic: Service Industry
• Index: Business

Water scarcity is an increasing problem in many parts of the world, yet conventional supply-side economics and management are insufficient to deal with it. In this book the role of water trading as an instrument of integrated water resources management is explored in depth. It is also shown to be an instrument for conflict resolution, where it may be necessary to reallocate water in the context of increasing scarcity.

Recent experiences of implementation in different river basins have shown their potential as instruments for improving allocation. These experiences, however, also show that there are implementation challenges and some limitations to trading that need to be considered. This book explores the various types of water trading formulas through the experience of using them in different parts of the world. The final result is varied because, in most cases, trading is conditioned by the legal and institutional framework in which the transactions are carried out. The role of government and the definition of water rights and licenses are critical for the success of water trading.

The book studies the institutional framework and how transactions have been undertaken, drawing some lessons on how trading can improve. It also analyses whether trading has really been a positive instrument to manage scarcity and improve water ecosystems and pollution emission problems in those parts of the world which are most affected. The book concludes by making policy proposals to improve the implementation of water trading.

1 Introduction

Myths, principles and issues in water trading

Ronald C. Griffin, Dannele E. Peck and Josefina Maestu

There is growing evidence of increasing water scarcity in the world. This general scarcity is often exacerbated by the more frequent occurrence of extreme weather events. Cities and agriculture are struggling to make ends meet with their current water endowments. Increasing competition often means that there is not enough water for fragile habitats and the natural environment. Two linked features of the problem are rising water scarcity and more expensive infrastructure. Both issues underscore deficiencies within the conventional supply-side alternatives that are commonly suggested.

A key water management option – water trading – appears to be underutilized. Water trading can contribute to the efficiency of water use, and it can decouple economic growth and water use, thus contributing also to environmental flows. This book seeks to illuminate the role of water trading as an instrument of integrated water resources management. Trading is also a potential instrument for conflict resolution, where it may be necessary to reallocate water to address scarcity.

Water trading is based on voluntary agreements to transfer water among different users. Recent experiences of implementation in different river basins have demonstrated the potential of trading as a strategy for improving allocation. These experiences, however, also show that there are implementation challenges and some limitations to be considered.

Mounting experience with water trading is reshaping not just the management of this resource, but the way we envision it. Where there were once substantive barriers to reform because “water is different,” institutional change in various parts of the world is demonstrating that water is not so different. At the root of this revelation is water’s intersection with people. There’s a reliable constancy about people: their respect for a commodity is related to its experienced financial value. By tapping into this feature of human behavior, water trading is making some progress in alleviating excess demand in many regions of the world. Moreover, if economists are right about the adjustments that people are pursuing under trading, then this reduction in excess demand is improving overall human welfare. Whether these claims are true and whether these policies can be further refined will be analyzed for many years to come. For now, water trading represents an intriguing group of policy opportunities to harness human self-interest for improved water management.

Water’s peculiarities pose challenges, however, and water trading is not a panacea for scarcity. In spite of these limitations, the hardships of scarcity are spurring many governments to give water trading a try. Policy experimentation is under way, especially in water-scarce parts of the world, as countries seek out better ways to address the unique challenges that come with water. These trials and their results are a boon for water-scarce regions that have yet to embark on reform efforts, for there are valuable lessons to be gained. To aid these opportunities, the objective of this book is to assemble many of these stories and attempt to isolate the emergent keys and hurdles to successful water trading. By placing many perspectives and experiences (not all of which are in agreement) “under one roof,” we hope to propel further investigation, experimentation, and reform. By bridging many countries’ contemporary water policy transitions, this text shows how ideas have evolved since Easter et al.’s 1998 book.

In the remainder of this introductory chapter, we aim to illuminate the water trading debate by clarifying basic terminology, dispelling some of its more divisive myths, highlighting a few foundations for success, and pointing out some persistent stumbling blocks. If these objectives can be achieved, readers should be primed to more systematically comprehend the water trading stories that follow.

Polarizing ideologies

Steadfast ideologies and confused rhetoric have frustrated the advance of water policy. To get on the right path, so that the potential role of water trading can be accurately cast, people should set aside their prior indoctrinations and begin using terminology more accurately and consistently. This is difficult in ordinary water policy settings. Few decision-makers and voters have formal training in water management or economics, and therein lies a major hurdle. Limited education in either area allows dogma and symbolism to drive debate and subsequent policy decisions.

Two polarized “thought sets” are especially problematic. On the one hand is the “water is too different to sell” argument, which rejects water trading on the grounds that it is socially objectionable and doomed to fail before it even begins. On the other hand is the “water is no different from other commodities” perspective, which steadfastly promotes water trading as the best means to improve economic well-being. This pro-market viewpoint maintains that water trading is the natural solution. Although both sides have defensible origins, debate about water trading continues precisely because it neither fails miserably nor works perfectly. Moreover, fervent application of either of these perspectives tends to be harmful in policy design. Juxtaposing them, however, can help delimit the range of debate and pinpoint issues that need to be confronted.

Origins of water trading myths

Water trading opponents usually espouse a forceful, water-is-different view that tends to exaggerate biological requirements for water (i.e. classify nonneeds as needs), confuse capital scarcity with water scarcity, and claim a public entitlement to water. They sometimes add other arguments for good measure, such as preserving agrarian economies or protecting impoverished peoples. There is a lot of false imagery underlying rhetoric about water (Kelso 1967), obscuring both the nature of water scarcity issues and the true character of available policy approaches.

A polar ideology is offered by water trading proponents, who hold fast to the belief that a market system is solely capable of extracting the greatest economic benefit from scarce water resources. Mainstream economists often advocate this view, as do pro-business and freedom-from-government factions. Their faith in the omnipotence of markets makes it difficult for them to appreciate why water might be different. Economists even have an indisputable mathematical theorem proving that a market system for all commodities will result in an efficient economy. Students of economics are so well indoctrinated about the power of markets that they sometimes forget the special conditions required for this ideology to hold. The tripping point here is that some of these conditions are unmet when the commodity under consideration is water. This pitfall is well appreciated within certain fields of economics, but it can be too technical or unwanted to influence the market-faithful crowd.

The critique here will be that water is sufficiently different to derail disciplinary ideology about market performance, but not so different that it renders markets unproductive. Water trading is indeed imperfect, but with the right circumstances and design it can increase society’s net benefit from scarce water resources. To establish a viable platform for critiquing the water trading stories in this book, we begin by clarifying confusing terminology and dispelling common myths underlying the anti-trading viewpoint.

What is “water trading” and what is not?

Supplying water is a notoriously capital-intensive process, more so than all other utilities (National Research Council 2002: 12). Therefore, the pivotal social problem is often the scarcity of capital for capturing, pumping, treating, and conveying water, or for collecting and treating wastewater. This is not a problem to which the notion of water trading is applicable, and it is a mistake to confuse the privatization of water infrastructure with the assignment and trade of private property rights to water. Owners of privatized water infrastructure need not and commonly do not own marketable water rights. This is not to say that those who privately own infrastructure could not also have private ownership of raw water inputs (i.e. naturally occurring ground or surface water). They are compatible, but they address rather different social problems.

Some regions have ample raw water, but their publicly managed water utilities or districts lack the infrastructure or incentives to process and deliver this water to consumers. In some cases, private capital and private service delivery is introduced as an alternative solution to public capital. Here, privatization refers to ownership of built facilities and the right to profit from operating those facilities. The hope is that the pursuit of profit through the processing and transporting of raw water will result in improved facilities, more efficient operations, or a higher quality or more widely available product.

Other regions establish their facilities and operations successfully, but find themselves short on naturally occurring water to process and distribute. It is in these situations that the introduction of enforceable and transferable water rights, for at least a portion of a jurisdiction’s water resources, may make a social contribution. Without any changes to infrastructural capacity or its ownership, water law can be reformed to transform a system of public property in water¹ (including private use rights) to one where a portion of a jurisdiction’s water use rights is regarded and enforced as a divisible, transferable, privately managed asset that can be bought, sold, or leased, in whole or in part. While it might be said that the water resource has been privatized in these circumstances, this term invites confusion with infrastructure privatization and is not advisable. Separation of these two issues will help clarify whether trading opponents object to privately held water rights or infrastructure privatization.

The public’s right to water

The anti-trading viewpoint commonly argues that we should not assign private rights to water because everyone has a right to water. Actually, all people do have this right if a government’s political process decides they do, just as a society may decide all people have a right to food, a minimum wage, housing, or health care. Regardless of society’s decision, this circular argument sidesteps the real issue at hand: how to manage water resources when they are scarce. Moreover, public rights can be reserved in all transitions to tradable water.

Societies often manage important resources (e.g. food) by creating private property rights to them, thereby establishing incentives for more efficient production and consumption of these scarce things (with appropriate interventions to deal with externalities and other market failures). This strategy has often been successful for non-water resources, such as land. Moreover, it is not uncommon for a government to partition a resource, assigning private use rights to a portion of it while keeping the remainder within the public domain (such as when private land coexists with public parks, forests, or wildlife reserves). Environmental water reservations and water rights for public taps and other publicly provided water or wastewater services can easily coexist with private property in water. Whether a full or partial private property strategy can be usefully applied to water is the question at hand. It is not helpful to reject water trading on the grounds that it conflicts with public rights. The two are not incompatible and may complement each other, as the land example illustrates.

Property rights as a key to success

Water use rights are pivotal for water trading. The effectiveness of private property rights hinges, however, on the extent to which they can be unambiguously defined, well enforced, and readily transferred. Some resources and goods are more conducive to management via private property rights, while others are better suited to common property rights or state ownership. Institutional economics informs that a private property right system has both pros and cons, and may not be appropriate in all circumstances. It is well recognized, for example, that private property rights can quell the race to use water resources before others do (i.e. the tragedy of the commons), but they can also be expensive to establish and enforce. If these costs outweigh the benefits of improved resource management, private property rights might not be justified.

Similarly, private property rights can facilitate the reallocation of water to higher-value uses. However, private water rights can also be costly to transfer when third party impacts (externalities) must be controlled via administrative oversight processes. In this case, trade might not move water to its most valued uses, and the other benefits of private water rights (e.g. preventing over-exploitation) might be underachieved.

Thus, even completely defined and enforceable water rights are not fool-proof paths to efficiency. No property rights system can eliminate all inefficiencies or resolve all disputes. It is therefore important to consider relative strengths and weaknesses of each system. The system that maximizes society’s net benefit from a particular water resource will depend largely on the characteristics and uses of that resource, some of which create the potential for market failures. These failures certainly reduce the effectiveness of water trading, but they do not imply that trading is outper-formed by alternative policies.

Market failures as a stumbling block to success

Water trading achieves a socially optimal allocation of water only if the following conditions hold: the market is highly competitive (i.e. individuals cannot control price); buyers and sellers exclusively enjoy and incur all benefits and costs associated with their decisions (i.e. no externalities, public goods, or missing markets), and the market does not suffer greater transaction costs or information imperfections than other allocation mechanisms. These strong conditions clarify why water trading cannot be the panacea that protagonists want it to be. Nearly every water resource setting violates at least one, if not several, of these conditions. The question is whether market failures are sufficiently severe to render water trading inferior to alternative approaches. Crucial elements of the answer must attend to the important matters of public goods, externalities, and transaction costs.

Is water a public good?

Public property in water does not imply that water is a public good. The use characteristics and ownership institutions of a resource are two separate matters, yet public goodness (when actually present) does raise suspicions about private property’s ability to assist water scarcity problems (Myles 1995: ch. 9). Illumination of this matter is best achieved by relying on strict economic doctrine to assess whether a good is public. By definition, a pure public good is both non-rival in its use and non-exclusive. Acting in concert, these two properties interfere with a market’s ability to produce and allocate a commodity efficiently. Hence, the more a given water use takes on these two public good attributes, the less likely it is that water trading is a beneficial instrument for managing that use.

It is a gross oversimplification to label water as a public good, yet some uses of water do constitute public goods. To correctly resolve the matter, one must emphasize the different uses of water as distinct applications and then pose the non-rivalry and non-exclusivity queries. Consider a farmer using water for irrigation. As a result of this irrigation, some of the applied water evaporates, transpires into the air or seeps into the soil and is gone (rivally consumed) relative to alternative uses in the area. A slight portion of the applied water may be embodied in the crop and be removed with the harvest (also rival). The remainder of this irrigation water may return to the originating watercourse as runoff, likely at a downstream location where it is unavailable to alternative users in the irrigator’s vicinity. Again, the farm’s use of water is rival with others within the immediate area, and is therefore not classifiable as a pure public good. Nor is the farmer’s use of water non-exclusive, because well practiced administrative options are available for denying/regulating/pricing water to the farmer (regardless of whether those options are actually practiced). Because the farm’s use of water is rival and exclusive, it is not a public good. Notice that both properties are assessed with respect to the technical character of the good without regard to in-place institutions and procedures. This is because the definition of a public good revolves around whether rivalry and excludability are possible for that use, not whether the...