Asghar Sabbaghi

Economics of water resources : from regulation to privatization

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.

Water Demand Side

The characteristics of the demand for water with regard to both quality and volume, as embedded in the interrelations between supply and demand, can be ascertained by considering the patterns of water withdrawal, and deliveries by and for the basic blocks of users. These include residential customers, public facilities, commercial and industrial users, thermoelectric plants, and farms (for watering livestock and irrigating crops). Relying for illustrative purposes on United States water data for the mid-1980s (see Figure 2.1), we note first that public supply deliveries account for about 8.3 percent of total daily water uses—directed to residential users, and also partly to commercial and industrial customers—while the rest is accounted for by self-supplied withdrawals, as well as by certain amounts of water recycled and reused.

Water Reuse and Recycling

Proper wastewater treatment is now recognized as an indispensable instrument for combating waterborne microbial diseases and infections, as well as an appropriate means for expanding through water recycling and reuse the efficient management of an increasingly scarce, but essential, natural resource. While quality considerations and public acceptance may restrict certain uses of treated wastewater, its efficient utilization for appropriate purposes may release other quality waters for other ends, and thus expand total water supply. Particularly in agriculture, the reuse of treated wastewater and drainage water can release freshwater for higher-value or for more readily accepted use, and reduce fertilizer consumption. Limits on available water resources in certain parts of the United States have long suggested the need for a public policy for water reuse. California, for instance, has long been the leading state with respect to water reuse.

Regulations Compatible with Privatization

Given the dynamics of population growth, the continuous expansion of urban concentrations, the accelerated pace of technological change, and obsolete, often wasteful patterns of water use in agriculture, questions of water scarcity and of water’s efficient allocation are becoming increasingly acute. As we have pointed out, in analyzing water resource management, one can no longer cut off the issue of water quantity from that of water quality and attempt to deal with them separately. These are interrelated dimensions of a common problem. In addressing the complex problems of water demand one must simultaneously take into consideration the other side of the equation, namely that of the quantity, quality and diversity of the water supply, along with the possibility of water recycling and reuse. The problem of efficiency in water resource management can no longer be treated as a matter of engineering efficiency. It is necessary instead to focus on economic efficiency in the management of both the demand and the supply of water of various grades. Moreover, water can no longer be considered a public and free commodity, and its allocation cannot be made by administrative and judicial fiat using a supply-oriented approach. We must look at water from an economic perspective as a multi-product commodity, with its price representing not only the cost of the water supply, but also its value to the user.

Pollutants and Their Specific Impact

For many years, there have been efforts to develop an overall water quality index which would use selected physical, chemical, biological, and microbiological indicators in order to classify water resources according to their quality.

Market Processes in Water Allocation

Federal intervention in the development and management of water resources in the U.S. dates from 1802, when the Corps of Engineers of the U.S. Army was established. Since that time, public intervention, almost exclusively by the Federal Government, has grown to enormous proportions. Regulations, have been the most significant form of government interference intended to monitor water use and to protect a given function of water. Public ownership and operation in production of services in conjunction with other water outputs (hydroelectric power or municipal water supply) as well as public investments in structures (flood control dam to protect against damages from flooding) and infrastructure (navigable watercourses) have also been some of the traditional government intervention in water resources management. Water management has been viewed as an engineering issue and, as Driver (1986) notes, the concept of efficiency in water resource management has meant engineering efficiency in assuring water supply rather than economic efficiency in managing demand for and supply of water. Water has been treated as a free commodity: charges are not made for extracting water from surface or groundwater sources, but only for the costs of moving the water. The rights to the water, however, are often constrained in ways that limit or at least raise doubts about the legality of transfers to other uses and users. Historically, water for new users in the western states, for instance, was provided through appropriating water rights to which no previous claim has been established and through constructing water development projects to capture, store, and transport water to areas where local supplies are perceived as inadequate.

The Economic-Ecological System

Effluent regulations are generally examined in a model of environmental quality in which effluent discharges directly affect other agents through utility or production functions or through an unspecified damage function. The important case of water pollution presents special problems, however, since the effluents discharged affect other agents indirectly through their intake of water. Thus, individual water withdrawals and enhancement of the water supply by the decision maker will affect the impact of effluent levels upon consumers and the firms using the water. This chapter explores these interactions, using both a partial and general equilibrium analysis of effluent regulation and the water supplies when water quality is affected by these effluent discharges. We will examine first the relative importance of water in the production process and the alternative ways that water may enter the production function; second, the chain of reactions set in motion by the production, consumption, and their generation of pollution, as well as by the feedback of these reactions through the environment.

Impetus for Water Privatization

Dynamic population growth and scarcity of water resources, coupled with inertia in the conceptions and methods of water management, raise increasingly critical issues in the efficient allocation and distribution of water resources. During the 1980s the U.S. population rose by 23 percent in California (from 23.668 to 29.125 million), 25 percent in Texas (from 14.229 to 17.712 million), 31.5 percent in Florida (from 97.460 to 12.818 million), and 38 percent in Arizona (from 2.718 to 3.752 million). During the last two decades of the 20th century, population in these states was expected to increase by 41.5 percent, 42 percent, 58.2 percent, and 70 percent, respectively. With limitations in water supply threatening to impede long-term economic growth in these areas, and with the feasibility and cost-effectiveness of additional water supply projects decreasing, an urgent need has become apparent to develop new approaches and methods that can ensure better management and economical distribution of existing water supplies.

Quality-Discriminant Water Pricing

Decisions on the pricing of water services, as noted before, have traditionally been made according to legal, administrative, and financial criteria rather than economic considerations. There has been much focus on supply-side price strategies to alleviate or to anticipate conflicts between various users when supply is limited. Various pricing policies have been designed in various countries, the simplest being flat-rate tariffs, where water fees are not directly related to quantities of water used, and average-cost pricing. Other pricing policies include declining-block progressive-block tariffs, where succeeding blocks of units of water are sold at lower and higher prices, respectively, as well as two-part tariffs, which include a fixed component, often varying according to some characteristics of the user, and a variable component based on average-cost pricing in the form of a single volumetric charge (OECD 1987). It is argued that water systems experience decreasing unit costs with increasing usage, and thus that the declining-block tariff structure passes these cost savings on to consumers. However, the structure has no direct relation to the value of water and its opportunity costs. It also does not track direct cost, with the result that small users subsidize large users. Furthermore, given the growing scarcity of water due to competition between environmental quality requirements and economic activities requiring water, and the gradual elimination of more accessible sources of water supply, expansion costs are increasing and thus the assumption of economies of scale may not hold true.

Assessment of Administrative Controls

At the heart of the legislative approaches concerning pollution control codified in the Federal Water Pollution Control Act Amendments (FWPCAA) of 1972 and in the Clean Water Act (CWA) of 1977, as well as in the ensuing supportive legislative and regulatory measures, is the idea that the public sector provides for the treatment of pollution, while the private sector is primarily responsible for its prevention. Indeed, the acts embodied the contradiction of ecological ends and of technological means (Wolman 1988). The ecological concepts were fused in the drive to restore the chemical, physical, and biological integrity of the nation’s water. Yet, it was faith in technology that drove the prescriptive functions of the FWPCAA. What prompted a new emphasis on technology, the guarantor of clean effluents, was widespread dissatisfaction with prior emphasis on ambient water conditions. Industrywide technological standards for effluent control were adopted in the Act, as were precise dates for the attainment of successively higher standards. Mandated ecological changes, various regulatory measures and subsidies were used in order to make the private sector discharge its assigned responsibilities with respect to pollution prevention. State and regional plans then set forth options and projects chosen with the approval of the EPA—for which technical requirements were specified, “cost-effectiveness” assessments made, and grants requested and disbursed.