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1 Introduction

Water is a critical element of global economic activity and its supply and distribution involves enormous ongoing capital investment and operations and maintenance costs. The use of water is also subject to market forces. Water has a value, which varies depending on its scarcity, its production, treatment, and transportation costs, and the value of crops and other goods produced through its use. Water also has aesthetic, recreational, and environmental values. The demand for water, beyond that needed for basic human survival, is elastic in that cost influences the amount used (Fig. 34.1). There is some correlation between the rate of water use and the price paid by users (if any). Any meaningful discussion of water management, therefore, cannot ignore economic issues associated with the development and use of water resources.

Water has a dual identity as both a social and economic good. The basic characteristics of water preclude a true free market in water (Sect. 34.6). Allocation of water can be based on either economic efficiency or equity (i.e., fairness of allocation across economically disparate groups) (La Moigne et al. 1997). Although economic efficiency is clearly important, few would argue that maximization of wealth should be the sole objective of nations. Actions that increase societal economic efficiency with respect to water are not necessarily fair and could have the net result in making the poor poorer and the rich richer (Khouzam 2003). Reallocation of water can increase overall societal welfare, but there still may be losers in the process. In practice, countries usually strive to achieve some balance between economic efficiency and equity. The latter is necessary for social stability. The challenge is achieving social goals with respect to water, while also maximizing the economic benefits from the use of water.

Sandra Postel made two important observations concerning global water supply,

water is consistently undervalued, and as a result is chronically overused (Postel 1992, p. 156).

many of the water shortages cropping up around the world stem from the widespread failure to value water at anything close to its true worth (Postel 1992, p. 166).

An axiom often attributed to Benjamin Franklin notes than “when the well’s run dry, we know the true value of water.” In fact, assigning a value to water is far from a straightforward issue. In a free market system, the value of water is related to the willingness to pay for agricultural, domestic, and industrial users. However, the amount of water that users are willing to pay for depends upon the value of the use (e.g., high-value versus low-value crops), how the water is used (e.g., primary supply versus drought protection), and local and user-specific circumstances (Young 1996; National Research Council 1997; Winpenny et al. 2010). Similarly, the value of water can be evaluated by the willingness to accept compensation for giving it up. Willingness to pay or accept compensation is a monetary measure of the intensity of individual preferences (Young 1996).

When markets are absent or do not operate efficiently, economic evaluation of resource allocation decisions requires some means of estimating resource value be found (Young 1996). The value of water used for irrigation (and other purposes) can be quantified in terms of the marginal productivity of water, which the extra value of output that can be obtained from additional applications of water (Young 1996; Winpenny et al. 2010). With respect to irrigation, the value of water is the change in income with and without an irrigation project. This type of residual method is most accurate where water constitutes a significant fraction of the value of the output (Young 1996).

The economic value of water is not a fixed, inherent attribute of a good or service, but rather depends upon time, circumstances, and individual preferences (National Research Council 1997). Reliability is an important consideration. Domestic, industrial, and agricultural water users all place a higher value on reliable water supplies than on supplies with high risk availability (Young 1996). Even more challenging is assigning a value for the environmental services performed by water. Methods for evaluating the value of water were reviewed in detail by Gibbons (1986); Young (1996); National Research Council (1997); and Winpenny et al. (2010).

A fundamental water management issue is the allocation of water between different sectors in society (e.g., household, agricultural, and industrial). Efficient allocation of water between sectors to gain high returns and high levels of employment is fundamental to economic and political stability (Allan 1998b, 2001). Allocations (and how they are determined) always reflect political considerations together with economic realities (Lithwick 2000). Allocations based on economic considerations tend to promote efficiency in both the production and consumption of water, whereas other modes of allocation do not (Lithwick 2000). However, non-economic, sociopolitical considerations are still important.

Where water is scarce, it needs to be used efficiently in order to obtain the maximum benefits. Water use efficiency includes two basic approaches or components (Allan 2001):

  • technical or productive efficiency, which is concerned with obtaining increased returns for water use for a given activity, and

  • economic or allocative efficiency, which is concerned with allocating water resources to activities that provide the greatest economic value.

A critical issue is that increases in technical efficiency achieve very modest returns compared to economic efficiency (Allan 2001). Water is efficiently allocated when the marginal value of water (i.e., incremental increase in value that could be obtained by using a little more water) is he same across all classes of water users of water (National Research Council 1997). However, re-allocation is a political act and creates disadvantages to some and benefits to others.

An individual needs approximately 1,000 times more water to raise the food he or she consumes than the volume of water used for drinking. Food production requires most of a community’s water. Water for food production is, therefore, the strategic water use in any economy (Allan 1998a, b, 2001). In many arid countries, agriculture constitutes a very large percentage of total water use, but generates a small fraction of the total income of the country (e.g., Allan 1998a, b; Lithwick 2000; Wheida and Verhoeven 2007). The economic value of industrial water uses greatly exceeds the value obtained from the same volume of water used in agriculture. Since agriculture is the major user of water and has a low economic efficiency, it is an obvious target for reallocation to municipal and industrial users. However, increasing water and food demands go hand in hand with population growth, and decreasing irrigation could result in decreasing domestic food production, unless there is a concomitant increase in water use efficiency.

Reallocation of water from agriculture may have great sociopolitical implications. Societies find it difficult to admit that agriculturally marginal regions may not be worth farming (Toope et al. 2003). If a country is going to move out of agriculture, it is going to have to move into something else. A country must therefore determine what products or services (if any) it can provide and have a competitive and comparative advantage (Brooks 2000). The social and political costs of greater unemployment of agricultural workers who cannot find jobs elsewhere in the country may outweigh economic benefits from the reallocation of water. Economic analyses concerning water allocation, thus, need to consider less tangible and difficult price issues, such as social, national security, environmental preservation, recreation, and aesthetic values.

Although it is recognized that socioeconomic objectives should be considered in economic analyses of water use, objectivity is important in estimating the value of socioeconomic goals (Rogers et al. 1998). For example, rural irrigated agriculture has an economic value in alleviating poverty, but that value needs to be objectively quantified when determining the optimal allocation of scarce water resources.

Underpricing of water has serious consequences for the expansion, operation, and maintenance of water utilities. Construction and the operation and maintenance of new water infrastructure are major expenses, and it needs to be recognized that their benefits must justify the associated direct and indirect costs. The National Research Council (1995, p. 64) observed that

the question of whether consumers are willing to finance a new water supply system is an example of linking cost to demand and is, in fact, the central question guiding policy toward infrastructure improvements in developing countries today: Is the cost justified by demand?

Srinivason et al. (2010) noted that in developing countries, water systems reach a “low-level equilibrium” as water users invest in coping mechanisms. Water utilities may find themselves in a scenario where income from water sales is inadequate to maintain and expand the supply and distribution systems, but the necessary increase in rates (tariffs) for full cost recovery is very difficult or causes default on debt necessitating governmental subsidies. Some supply options, such as desalination, may have a cost than exceeds the economic benefits to the customers. Increased tariffs for piped water become particularly difficult after water users have invested in wells and other coping mechanisms. Once consumers have invested in private wells, they have access to a cheap backstop source of water, and their willingness to pay for expensive piped water system improvements will likely be lower (Srinivason et al. 2010). However, as incomes increase, consumers may choose the higher-cost and higher-quality option of a piped water supply (Srinivason et al. 2010).

Another economic obstruction to the creation of a reliable and high quality centralized water system to cities that are lacking them is indirect impacts. For example, some large developing countries contain major population centers not served by centralized water systems. Water is provided by a private cottage industry of water suppliers that truck water to individual homes, apartments, and businesses. In certain cases, this private water supply industry and the ancillary support businesses (e.g., truckers, tank suppliers, well owners outside of the city, and water treatment specialist) constitute a substantial economic base providing jobs and income to large numbers of people. The centralization of supply is very expensive to the end users especially in major metropolitan areas where disruption of streets and other underground infrastructure occurs during construction. The secondary economic impacts include displacement of the private water supply industry with downstream impacts to individual families and reduction of overall community income.

2 Water as an Economic Good

The basic premise behind the recognition of water as an economic good or resource with a monetary value is that the price people are willing to pay for it serves as a guide to its rational management (Fisher 1995). Market forces will allocate water to uses that bring the highest economic returns and create user groups capable and willing to pay a greater price. Treating water as an economic resource means less waste, confining its use to where it is really valuable, and preferring reallocation to new supply schemes where these are costly in economic or environmental terms (Winpenny 1994). Winpenny (1994, p. 112) concluded that

Promoting water markets and raising tariff decentralises the task of matching demand with supply, and mobilises every party behind solving the problem. Nothing less will suffice.

The concept that water is an economic good in the same sense as other commodities is controversial, particularly amongst farmers and agriculture-dependent economies where access to free or heavily subsidized water is taken for granted (Allan 2001). Part of the resistance is due to fact that many farmers could not survive if they had to pay a fair market price for their irrigation water supply. Artificially low prices send the signal that water has little value. Indeed, inefficient water use is simply the user’s rational response to low prices. Users can afford to be wasteful only when water is cheap (Anderson and Snyder 1997).

The issue of treating water as an economic resource in which users should pay the full cost extends into domestic supply. The National Research Council (1995, p. 67) noted that:

Many people believe that since water is essential to life, authorities are obliged to bring it to the population at little or no cost.

That water should not be sold or not even have an economic value in some instances may have religious, cultural, or traditional bases. Under Islamic law, shari’ah, flowing water and water in channels cannot be sold (Sect. 33.2). Tony Allan noted that

If nature does not deliver water free to users then users tend to assume that other agencies, such as governments, should emulate nature. However, this inclination to consider all water to be similar to rainfall, that is free, has very powerful consequences with respect to the perception of the value of the water compared with the real costs of engineering the water to points where it can be used. (Allan 2001, p. 113).

Water was recognized as an economic good in one of the four Dublin principles (formulated in the 1992 International Conference on Water and the Environment) and is an integral component of Integrated Water Resource Management (IWRM) (Global Water Partnership 2000). In order to extract the maximum benefits from water, it is recognized in IWRM that it must be perceived and treated as a resource that has value rather than being viewed as a ‘free good’. Clean, safe water cannot be produced and delivered without expense and someone has to pay for it (Segerfeldt 2005). Pereira et al. (2002) noted that resolutions to provide running water to the majority of households world-wide have failed, primarily because there has been no firm political will to charge realistic prices for the supply of water. The problem of inferior, inadequate water supply systems in most areas of the world is not one of water scarcity, but one of political determination to charge a sufficient price to cover the real total cost of the supply system (Pereira et al. 2002). Recognizing that water has an economic value does not equate to its being treated as a pure economic commodity, which risks a shift of public perception away from a sense of water as a common good, and from a shared duty and responsibility (Rahaman and Varsi 2005).

There are two schools of thought concerning the specific meaning of the concept that water should be treated as economic good (Van der Zaag and Savenije 2006; Kresic 2009). One school is a pure market approach in that water should be priced through free market with its economic value rising spontaneously from the actions of willing buyers and sellers. The second school of thought is that water use decisions should be based on integrated analyses of all the costs and benefits of alternative options, which does not necessarily involve actual direct financial transactions. Treating water as an economic good is considered to be about recovering the costs of providing water and making informed choices about the use, conservation, and allocation of water (Van der Zaag and Savenije 2006). Pricing should give the signal that water is in indeed a scarce good that should not be wasted (Van der Zaag and Savenije 2006).

Lest the idea that the resistance to water as an economic good be considered a phenomenon of developing countries, irrigation water in the Western United States has historically been heavily subsidized. Agricultural users and their representatives, who otherwise strongly believe in free market economic principles, pushed forward many water supply projects that provided heavily subsidized water. False economic analyses were widely used to give the perception that projects made economic sense, when in fact they could never be economically justified because the farmers could never afford the true cost of the delivered water (Reisner 1999).

The economic cost of water includes three main components (Allan 2001):

  • Delivery cost (e.g., costs to operate surface water irrigation systems and to pump groundwater).

  • Economic cost, which is the value of water itself as an economic asset that could be put to varied uses. It includes the opportunity cost (scarcity rent) of water use elsewhere in the economy and the value added by the use of water.

  • Intangible value as an environmental resource, which can also have tangible values involving fisheries and other water-related resources.

Opportunity costs are the costs borne by society resulting from depriving other sectors of the use of the water. Opportunity costs with respect to water use can be quantified as the difference in the net economic value of the goods that could be produced by different uses of a given volume of water. There is an opportunity cost associated with the use of water for agriculture if reallocation of water could have allowed for greater economic returns elsewhere in the economy. In practice, opportunity costs are difficult to accurately quantify, because water is not the sole or primary limiting factor and cost for many activities. For example, semiconductor manufacturing is a much more economically efficient use of water than agriculture, but whether or not a country has a viable semiconductor industry is invariably due to a deficiency of economic and technical resources, rather than water resources.

Rarely has the inherent economic cost or value of water been fully incorporated into management decisions. Instead, economic analyses of water use typically focus primarily, if not solely, on delivery costs. For example, economic analysis of wellfield projects have historically focused only on the capital costs to install the wells and associated infrastructure, and operational and maintenance costs, not the value of the water itself. It is only when groundwater is recognized and regulated as a finite resource, and is no longer “free for the taking” if one installs a deep enough well, is the value of water recognized.

The market for water can never really be free as is there is seldom, if ever, a truly competitive market, which requires a large number of buyers and sellers. Certain water uses are also often considered to have a social value in addition to the private value placed on it by its users (Fisher and Huber-Lee 2010). There are commonly no substitutes for water. Economic models have been developed that can allocate available water to maximize the total benefits from water, while also incorporating social and economic values (e.g., Fisher 1995, 2002). For example, subsidized water could still be provided to the poor as a social value. The absence of water trade denies potential buyers of water that could be used in a beneficial and profitable manner and also imposes an opportunity cost on the owner of the water rights that is equal to the amount of money that could have been earned through selling the water. Water trading on both an intra-national and international scale can result in win–win scenarios where both parties gain (Fisher 2002).

From an economic perspective, consumers of water should actually pay the marginal cost of water (i.e., the cost to obtain additional supplies) rather than the average cost (Winpenny 1994; Brook 1996). The optimum allocation system from a purely economic perspective is that which equates the marginal cost of supply with the margin benefits (shadow price) of the water in use (Winpenny 1994). The benefit from consuming the last unit of supply is equal to the cost of providing it.

3 Self-Sufficiency and Food Security

A conflict exists to varying degrees in many countries between the use of water for irrigation versus non-agricultural uses, particularly industry and urban domestic uses. The water management challenge requires achieving a balance between (1) economic efficiency, (2) food security concerns, and (3) sociocultural values. There is one school of thought that water allocation decisions should be based entirely on economic considerations. Adam Smith (1776) in his influential book “An Inquiry into the Nature and Causes of the Wealth of Nations” (Book IV Chapter II) noted that

It is the maxim of every prudent master of a family, never to attempt to make at home what it will cost him more to make than to buy…What is prudence in the conduct of every private family, can scarce be folly in that of a great kingdom. If a foreign country can supply us with a commodity cheaper than we ourselves can make it, better buy it of them with some part of the produce of our own industry, employed in a way in which we have some advantage.

The bulk of water use in arid regions is still for irrigation. It has been recognized that the use of water for irrigation is relatively inefficient in an economic sense. For every agricultural worker that is supported by irrigation, sixty to seventy industrial workers could be supported by use of the same water (Heathcote 1983). Hence, the case is made that in water scarce regions, the economically correct decision is to reallocate water from agriculture to other sectors that have a greater economic productivity and instead, purchase food from countries with more abundant water resources.

Putting opportunity costs aside, arid region agricultural projects may provide no pure economic value. Fadlelmawla (2009) noted with respect to farm projects in Kuwait, that production far from satisfies local needs for a few kinds of vegetables, let along providing any degree of food security. The farms also depend on expatriate manpower. Agriculture additionally costs the government substantially more through direct and indirect subsidies and contributes to the depletion of the countries water resources.

However, food security is a sensitive political issue that may supersede economic considerations. People have a deep intuitive aversion to being dependent on other economies for their water and food (Allan 2003a). Allan (2003a, p. 8) observed that

awareness of a dependence on water and staple food coming from outside their own sovereign territories can be very destabilizing.

Food supply represents a fundamental national security issue. It has been known from ancient sieges that it is possible to starve an opponent into submission. Food can be a more potent weapon than guns and bombs to achieve political objectives. It was suggested by some lawmakers in the United States in the 1970s, that the United States’ “grain weapon” could be just as effective as the Arab “oil weapon.” Although the use of such trade weapons in a globalized economy would ultimately be self-defeating, the possibility of such ill-advised political actions can never be excluded.

The withholding of food could also occur under non-aggressive situations. For example, if global food production were to undergo a sudden decline due to unexpected climatic conditions, there would be intense political pressure for normally food-exporting countries to stop or reduce exports so as to meet the internal demands. What would a nation dependent on food imports do under such circumstances? Food is a high bulk, perishable commodity, which precludes significant long-term stock-piling particularly for populations in the millions to hundreds of millions. However, in an increasing number of nations in arid and semiarid regions, it is understood that self-sufficiency of the food supply is or will be not achievable, especially on a long-term basis, because irrigation water demands exceed available freshwater resources. Although it is true that total food self-sufficiency is not practicably possibly in some countries and regions, this does not necessarily negate the value of some local food production.

4 Virtual Water

The term virtual water is a metaphor that was created by Professor Tony Allan of King’s College London and the School of Oriental and African Studies in 1993. It refers to the amount of water use involved in the growing and manufacture of products that are traded. Virtual water has also been referred to as the embedded water, and as Professor Allan (2003a) noted, the basic concept had been previously discussed by others. The term “virtual” refers to the fact the most of the water used to produce a product is not actually present in the product.

A critical implication for the virtual water concept is that water used, for example, to grow a crop (or used in the production of other traded items), is in essence exported by the producer and imported by the consumer. For example, the production of one metric tonne (1,000 kg) of grain requires roughly 1,000 tonnes (cubic meters) of water (Allan 1998a, b, 2003a). The trade of a tonne of grain thus involves the trade of 1,000 tonnes of virtual water. Food imports, particularly of cereal grains, are important indicators of water deficits (Allan 2001). Different foods and products have different virtual water contents. For example, it requires about 16 times as much water to produce a kilogram of meat as to produce a kilogram of wheat (Allan 1998a, b). Valuing virtual water is a problem as the value of water varies with circumstances. In some humid regions, water in the soil profile is essentially free (Allan 2003a).

From a national or regional perspective, water deficits can be addressed through the importation of virtual water. For example, the Middle East/North Africa (MENA) region is extremely water deficient in the sense that existing water resources are inadequate to meet the needs of rapidly growing and urbanizing populations (Allan 1998b). Total water self-sufficiency requires that a nation have sufficient local water to provide drinking water, water for industry and services, and water for food and other essential agricultural production (Allan 2003a). The MENA region ran out of water in the 1970s in the sense that local water resources became inadequate to locally produce the food supply of the region (Allan 1998b, 2001).

Important of virtual water in the form of food allows for global economic processes to ameliorate serious local water shortages (Allan 1998a, b, 2001, 2003a). As a high volume and low unit value commodity, it is by far a less expensive option to import 1,000 tonnes of virtual water in the form of a tonne of grain, than to import or produce by desalination 1,000 tonnes of water to locally grow 1 tonne of grain. Water embedded in food commodities can be mobilized very quickly to address periodic water shortages (Allan 2003a).

The ideal situation is for regions with excess water supply to be virtual water exporters and regions with water deficits to be virtual water importers. Water-scare countries might wish to import products that require a lot of water in their production and export products or services that require less water (Hoekstra and Hung 2002). However, the opposite often occurs where water intensive crops, such as fruits and vegetables and fiber crops, are grown in arid and semi-arid lands. Global trade in virtual water lies at the heart of some of most intractable hydrologic crises on the planet (Pearce 2006).

Scare water resources are used to grow crops for export, which results in the export of virtual water from water scare regions, further depleting the local water resources (e.g., Saudi Arabian wheat exports of the past).

The reliance of virtual water importation is a solution to local water scarcity, but it has national and economic security implications in the same manner as many industrialized countries have become highly dependent on imported energy. Not all factors involved in the evaluation of virtual water strategy are easily quantifiable, such as food security, environmental externalities of large water infrastructure, and political stability (Yang and Zehnder 2007). Food security through trade also leaves countries increasingly vulnerable to changes in agricultural commodity price variations.

Although there appears to be sufficient ‘virtual’ water to meet regional demands, Allan (2001a, p. 56) cautioned with respect to the MENA region that.

it behooves the governments of the MENA region to evaluate the position with as much vigilance as those who manage another vulnerable economy, that of Japan, study global energy resources and the future availability of key strategic minerals.

Economic diversity and strength will enable even very seriously water deficient economies to adopt conflict-reducing environmental and economic policy solutions (Allan 2001a). A corollary is that virtual water trade needs the backing of amiable political relationships and that hostilities impede the development of virtual water trade (Yang and Zehnder 2007). With respect to virtual water trade in Egypt, El-Sadek (2010) reported that local scholars did not favor reliance on virtual water because of the perception that food-exporting countries are mostly western countries. Since the relationship between Egypt and western countries is dominated by skepticism and fear of domination, the dependence on virtual water importation could lead to political instability and domination by western countries. El-Sadel (2010) also noted that before adopting the virtual water policy option, Egypt needs to be assured that it can have fair and secure trade with water abundant nations. Such attitudes are understandable and certainly not unique to Egypt; there is general apprehension amongst non-western countries about becoming dependent upon western countries for something as basic as their food supply.

The World Water Council (2004) noted that

At the global level, virtual water trade has geopolitical implications: it induces dependencies between countries; it is influenced by and has implications on the world food prices as well as on the global trade negotiations and agreements on tariffs and trade. Indeed the issue of virtual water is related to that of globalisation, which raises a concern among the general public. This can be understood from the fact that increasing global trade implies increased interdependence of nations. This can be regarded either as a stimulant for co-operation or as a reason for potential conflict.

Hoekstra and Hung (2002, 2005) quantified the volume of virtual water trade flow between nations in the form of crops in the period 1995–1999 and put the virtual water trade balances of nations in the context of national water needs and availability. The basic approach is to multiple crop trade flows (ton/yr) by associated virtual water content (m3/yr, gal/yr). Countries with the largest virtual water exports were the United States, Canada, Thailand, Argentina, and India. The largest virtual importers were Sri Lanka, Japan, the Netherlands, Republic of Korea, and China.

The Hoekstra and Hung (2002, 2005) procedure starts with the determination of the crop specific water demand (SWD[n,c]) for crop “c” in location “n” in m3/ton

$$ SWD[n,c] = \frac{CWR[n,c]}{CY[n,c]} $$
(34.1)

where,

  • CWR[n,c] = crop water requirements (m3/ha, gal/acre)

  • CY[n,c] = crop yield (ton/ha, tons/acre)

The crop water requirement is the cumulative crop evapotranspiration over the growing season, which Hoekstra and Hung (2002) estimated using the standard procedure of multiplying reference crop ET rate by a crop coefficient.

The virtual water trade (VWT; m3/yr, gal/yr) flow associated with a crop is calculated by multiplying the crop trade (CT; ton/yr, tons/yr) by the specific water demand.

$$ {\text{VWT}}\left[ {{\text{n}},{\text{c}}} \right] \, = {\text{ CT}}\left[ {{\text{n}},{\text{c}}} \right] \, *{\text{ SWD}}\left[ {{\text{n}},{\text{c}}} \right] $$
(34.2)

Using this approach the net virtual water import (NVWI) flow for a nation can be calculated as the sum of the virtual water trade flows of all imported crops minus the flows for all exported crops. A negative total indicates that there is a net export of virtual water from the country. The water footprint of country is the sum of its total domestic water use (WU, m3/yr) and NVWI.

The water dependency index (WD) is a measure of a country reliance on virtual imports to meets its water needs

$$ WD = \frac{NVWI}{WU + NVWI}*100 $$
(34.3)

WD is equal to 0 if a country is a net exporter of virtual water. The water self-sufficiency index (WSS) of a nation is a measure of the degree to which a country meets its water needs through domestic sources. The WS and WD indices are related as follows:

$$ {\text{WSS }} = { 1}00 - {\text{WD}} $$
(34.4)

The Hoekstra and Hung (2002) comparison of water dependency versus water scarcity shows that some countries departed from the expected correlation between degree of water dependency and water scarcity, as defined by the ratio of water use to water availability (internal renewable water resources). Some countries have a low water scarcity and high virtual water dependency (e.g., Norway and Switzerland) while other countries have relatively scarce water resources but have a high degree of water self-sufficiency (e.g., Qatar and Egypt).

Yang et al. (2006) examined the water use efficiency embodied in the virtual water trade. A key point raised by Yang et al. (2006) is that globally, the total volume of food imported is approximately equal to the global volume of food exported. However, this equilibrium does not apply to the global virtual water trade because the water used for producing a given amount of food may differ between the importing and exporting sides of the trade. Globally, a water savings results when virtual water is exported by countries with water productivity that is higher than the importing countries. For example, if a country in which 100 m3 of water is needed to produce a given volume of wheat, instead imports that wheat from a country in which only 70 m3 is used, then there is a net savings of 30 m3 of water. The global trade in wheat and maize has resulted in a 41 and 59%, respectively, reduction in global water use (Yang et al. 2006). The importation of virtual water allows the importing country to save domestic water for higher value uses.

The type of water used for irrigation and its opportunity costs also need to be considered when evaluating virtual water trade (Yang et al. 2006). Virtual water is often divided between ‘green water’ and ‘blue water’. Green water refers to the volume of rainwater that is lost to evapotranspiration during the growing of the crop, but is also used to refer to soil moisture (i.e., water source for rain-fed or dryland agriculture). Blue water refers to water obtained from surface water bodies and aquifers that is lost to evapotranspiration. The blue water is equal to the irrigation withdrawals minus any aquifer returns. The term ‘gray water’ is used to refer to the volume of water that becomes polluted during the production of a crop or product (Water Footprint Network 2009).

The opportunity costs of blue water are much greater than that of green water, as blue water can more readily be put to other uses. For example, groundwater can be put to a variety of uses, but there are very few alternatives for the use of soil moisture. Trading of green virtual water is thus more economically efficient than trading blue virtual water from an opportunity costs perspective (Yang et al. 2006; Yang and Zehnder 2007). For the major virtual water exporting countries (United States, Canada, Australia, France, Argentina, Thailand, and Brazil), the exported water is overwhelming green.

Importing food effectively reduces the domestic demand for water. However, strictly speaking virtual water import typically does not generate a real savings in water in water scare countries in the sense that there as a reallocation of blue water from agricultural to non-agricultural sectors. Instead, virtual water import has allowed people to be better nourished (Yang and Zehnder 2007). More food becomes available than is possible to produce locally with existing water resources.

Virtual water trade can have some adverse impacts. Some net virtual water importers are not water scarce, and the importation of cheap food depresses local crop prices to the detriment of local farmers (Yang et al. 2006). There are also environmental and water resources impacts associated with virtual water exportation. Increased production may come at the expense of natural environments as more land is brought into production. The heavy use of fertilizers and pesticides to achieve high productivities has resulted in groundwater and surface water contamination (Yang et al. 2006). The lack of financial resources deprives poor countries of the opportunity to purchase food and participate in the global virtual water trade (Yang et al. 2006). The need to purchase food also drains limited financial resources that might be better put to economic development activities.

Allan (2003b) also noted that virtual water may be the second best solution rather than optimal solution. The optimal solution would involve measures to increase returns of water by technical and allocation techniques. However, under some of the global climate change scenarios, there may be no alternative to certain regions other than virtual water importation (Chaps. 38 and 39). As population grows and climate change occurs, a full global reevaluation of the economics of virtual water flows will be required to meet demands.

5 Water Ownership and Market-Driven Solutions

Who owns water and who has the right to use it is becoming an increasingly contentious issue as demand for water increases. Water management policies that were developed during times when water demands were modest relative to supplies may become obsolete under conditions of water scarcity. However, water management laws, regulations, and policies may develop deep cultural and social roots. Great inertia often exists against changes in long established water use laws and policies. The entities that currently possess rights to water have a very strong vested interest in maintaining the status quo. Clearly, the owner of a right to water, which may have been obtained through the purchase of land at market value, would strongly object to reductions or restrictions on the use of the water, which would diminish the value of the property. Alternatively, it is viewed as perverse by many that the rain that falls on the roof of the house that one owns may be legally belong to a downstream surface-water right holder, which is the current situation in some states in the Western United States.

Much has been written over the past two decades on the merits of free water markets versus government regulation of water, with the expressed opinions typically reflecting the philosophical beliefs of the owner rather than objective empirical data. Water market advocates propound that market systems promote efficient use of water through pricing mechanisms and results in water being allocated to where it results in the greatest net economic returns. Government intervention, it is argued, results in distortions in the market and inefficient water use. It has also been argued that governmental regulation of water results in its politicization. For example, Anderson and Snyder (1997, p. 21) noted that

It will not do to assume that because they are in the public sector they are working toward the public interest. Votes, campaign coffers, influence and budgets are all factors that affect decisions in the political sector. Even where politicians want to do what is good for the constituents or for the country, they still face the problem of knowing what the people want.

Lack of ownership of water and other impediments to the transfer of water ‘rights’, discourage market-driven conservation and optimization of uses. It has been proposed by many that a freer market for water would increase the overall efficiency of water use. The increased efficiency would be both physical (hydrological) and economic. In the economic sphere, water may be transferred from low-value uses to high-value uses if individuals hold legal rights that can be sold to others (Anderson and Snyder 1997; Winpenny 1994; Revenga 2001; Johnson et al. 2001; Clayton 2009; Glennon 2009; Alder 2009). The right to a volume of water in a marginally productive agricultural area may be worth more than the value of agricultural operations. There is thus an opportunity cost associated with water use, in that more money might be obtained from selling the water. Postel (1993) noted that almost everywhere the value of water for crop production is less than its value for other uses. For example, in California, agribusinesses have been using 80% of the state’s limited freshwater, while producing 3% of its economic output (Solomon 2010). The issue is not whether water is used efficiently in irrigation but whether irrigation is an efficient use of water (Brooks 1997).

Transfers of water rights thus increase the overall economic efficiency of water use. In southwestern United States, municipalities are purchasing water rights and agricultural land with associated water rights to secure supplies to meet growing urban and suburban needs. If the price of water is greater than the valued earned from irrigation, then a farmer could sell or lease the water right and convert his fields to non-irrigated cropland, adopt more efficient irrigation practices, or take the fields out of production altogether. The purchased farms are referred to as ‘water ranches’. Winpenny (1994) observed that farmers who decide to sell their water instead of using it on low value crops are doing themselves, as well as society, a favor.

Water markets have also been argued to increase the flexibility of water systems, which will likely be an increasingly important issue in response to climate change (Adler 2009). Water pricing can be effective in reducing demands during drought periods. Market forces could also temporarily reallocate water to its greatest value uses during periods of increased water scarcity.

In addition to increasing economic efficiency, market-drive transfers of water could also increase the hydrologic efficiency of the use of water. As the economic value of water increases, a greater incentive will exist to be more efficient in the use of water and to avoid waste. Farmers may adjust to using less water by becoming more efficient. If a farmer can profit from the sale of water, he will be motivated to invest in conservation practices that will save water and make water available for other remunerative uses. When farmers sell or lease water rights, they may fallow the least productive fields on the farm, shift the crop mix, or change the irrigation system (Glennon 2009). Ownership of water also creates incentives for investments that improve the efficiency of water use and increases the availability of water through exploration and development activities (Donoso 2006). “Salvage legislation” would allow farmers who conserve water to acquire valuable transferable water rights (Adler 2009).

The principal objections to an entirely free water market system stem largely from the recognition that water is also a social good and that water trading can have significant third party effects. There is a common belief that water is a public good that is owned by all and should, therefore, not be subject to economic forces. Similarly, there is the concern that if water is treated purely as a commodity, then the wealthy could be able to monopolize the resource at the expense of the poor. Turning water into an economic commodity also results in a windfall to water rights holders who may have obtained the right for no or just a nominal cost. Additionally, treating water as an economic good could exclude non-market considerations, such as environmental protection and cultural issues. However, all of these concerns currently occur to some degree in jurisdictions in which the transfer of water is restricted.

The importance of historic water use to local culture should not be discounted. For example, Young (2002) noted that in Oman, rural village and aflaj (qanat) supplied oases lie at the heart of Omani culture and tradition. It is, therefore, essential socially and politically to support and maintain this heritage, which is a concern that is typically ignored in estimating the economic value of water.

The question is not whether market solutions used to manage scarce water resources is a good or bad idea, but rather that its results will depend upon how it is implemented. Solomon (2010, p. 380) observed that

Whether the commodification of water ultimately leads to efficiency gains that ease water scarcity or results instead in an unregulated regime of water pricing and allocation that condemns the water poor to choose between desiccated, unhealthy lives and desperate remedies, depends on the terms by which societies choose to inject market forces into the traditional, public realm of water.

6 Water Markets

Once water is recognized to be an economic resource, the next step is to obtain the maximum or at least a net increase in the economic value of the use of water, which can be defined as the net benefits (total benefits minus total costs) obtained from given volume of water. Water is reallocated in some manner from low value uses to higher value uses. The reallocation can occur through market or administrative (command and control) mechanisms. When considering the benefits and drawbacks of water markets, it is important to go beyond philosophical beliefs, either for or against, and consider real-life issues. Water markets have the capability to increase the economic efficiency of water use, but it is clear that the properties of water preclude a true free market. In many aspects, water markets fail to meet the basic conditions necessary to yield accurate incentives and foster efficient resource use (Frederick 1995; Livingston 1995).

The strongest argument for water markets is that economic incentives can increase the efficiency in water use, and prompt the development of new sources of water and alternatives to water use. Morriss (2006, p. 1010) enthusiastically noted that:

once these markets develop, we will unleash the enormously creative power of entrepreneurs on the problems of inadequate water, inefficient uses of water, and poor quality water.

It must be emphasized that a requisite for any free market is that there be numerous buyers and sellers. Buyers must also have choices. When there are usually no practical alternatives to water supply, then there is no choice, and hence a free market is not possible (Van der Zaag and Sevinije 2006). In the case of water, one also cannot have a free market if a disproportionate amount of the resource is the hands of one or several users.

In a free market, the costs and benefits of water trades must be internalized to the buyer and seller, which is usually not the case for water. Third party impacts are a significant concern (Sect. 34.8). Livingston (1995, p. 205) observed that

without adequate institutional arrangements, efficient utilization is inhibited because all costs imposed by water users are not necessarily born by the users themselves. That is, private costs and benefits diverge from social costs and benefits, which yield serious distortions in allocation.

In practice, a mix of market and administrative mechanisms are necessary for the reallocation of water to obtain maximum benefits, and that the position on the spectrum between market and administrative control will depend upon country specific conditions (Livingston 1995). Local water use traditions and regulations need to be considered in the development of water marketing systems.

A precondition for water markets is the existence of enforceable property rights to the water (Winpenny 1994). For water markets to flourish, the efficiency gains from transferring water to higher value uses needs to be large enough to offset the transaction costs (Winpenny 1994). A water market also requires a means for the physical transfer of water to occur. The bulkiness and low value per volume of water often makes it uneconomical to transport it from water-rich to water-scare regions.

A distinction is usually made in the regulation of water between the actual ownership of water and the right to use water. Surface- and groundwater are often considered to be property of the state and, therefore, non-transferable to private parties. However, the right to use water may become private property that is tradable. Donoso (2006), based on Chilean experience, proposed that the main conditions to establish a water market system based on water rights are:

  • relative water scarcity,

  • secure water use rights,

  • clearly defined water use rights,

  • well regulated water use rights markets,

  • adequate inventory of water resources, and

  • efficient conflict resolution system.

Water scarcity is an obvious prerequisite for a water market. If new sources of water are still readily available, then there is usually little economic incentive to trade existing rights. A fundamental requirement for water markets (or any other market) is that water rights be legally established and protected. Potential buyers of water rights must have confidence that purchased water rights would provide them actual water. A basic model for water trading is a “cap-and-trade” mechanism whereby a government agency determines the maximum allowable yield of the resource (e.g., total annual groundwater withdrawal from a basin). Allocations (i.e., rights or permits) for the use of shares of the annual yield are considered private property and are tradable.

The initial allocation of water rights is often the most controversial part of water marketing schemes (Tietenberg 2002). Initial allocations of commons in general may be made be based on (Tietenberg 2002):

  • random access (lotteries),

  • first come, first serve (historic use, priority, grandfathering, prior appropriation),

  • administrative rules based on eligibility criteria, and

  • auctions.

Historic use or priority are the most commonly used methods for the allocation of water and are a logical bases for the establishment of tradable water rights, because users may have already invested in the development of infrastructure for the use of water and have become dependent on the resource. Anderson and Snyder (1997) argue forcefully that water rights established under the prior appropriation doctrine of the Western United States can serve as the foundation for water markets.

The issue of fairness and equity arises when initial tradable water rights are established. A right to use scarce water can be very valuable. Hence, granting of tradable water rights allows for some users to acquire a substantial amount of wealth for what may have been obtained for a very modest investment (i.e., just filing the required paperwork). In some cases, excessive water rights were obtained by landowners based on inflated estimates of their actual needs. Water rights may have been granted at no direct cost, other than administrative costs. Later users are forced to purchase water at market prices, which the sellers may have obtained essentially for free. However, even where tradable water rights are granted for free, they can still result in an increase in the economic efficiency of water use as they are later tradable to higher value uses (Tietenberg 2002, and references therein).

Effective water markets also require effective monitoring and enforcement against overuse and unpermitted use. Where water has a high economic value temptations exist for water users to cheat and use more water than they are entitled. Unauthorized use by parties that do not hold permits poses a threat to the both the resource and the water market. Water rights have little value if others who do not have a permit can abstract water with impunity. Thus, the paradox exists that in order to have a “free” market, considerable government intervention may still be necessary to protect water rights and to prevent hoarding. The impacts of water trading on third parties must also be considered (Sect. 34.8).

An additional factor that may impact water markets is climate change. The quantity of water, and therefore the value of water rights based on historic use and runoff patterns, becomes less certain as hydrologic conditions change (Frederick 1995).

7 Chilean Water Market Experience

The Chilean model of water rights and water resources management has become a paradigmatic example of the free-market approach to water law and economics (Bauer 2004). Water marketing in Chile and the Western United States were compared by Mentor (2001). The 1981 Water Law in Chile declared that water is public property to which the state can grant private right of use. Chilean water law recognizes various types of rights to use water including consumptive, non-consumptive, permanent, contingent, continuous, discontinuous, and alternative, and combinations of these rights (Donoso 2006).

Water rights are free, but an auction is used when there are competing claims on the same water. Water rights are separated from land ownership and once granted water rights are fully protected as private property rights. The goals of the 1981 Water Law were to increase investment in irrigation infrastructure and to increase the productive value of water uses by relying upon market forces to stimulate efficiency and to stimulate the development of high-value agricultural uses (Bauer 2004). In contrast to Western United States water law, a water rights holder in Chile does not have an obligation to use the right. Thus, the Chilean water laws in practice encourage hoarding of water, but do not encourage the use of water for its own sake merely to avoid relinquishment of the water right through nonuse (Mentor 2001). Water rights could be obtained by parties with no intention of using the water in the foreseeable future, if at all, which excludes the water from beneficial use by others. As noted by Bauer (2004, p. 55):

by defining private water rights in a manner that includes no duties or obligations to public interest, the code favored private speculation, hoarding, and monopoly of water rights, and had undermined the incentives for using water rights in economically productive activities

While it was widely recognized that hoarding of water was economically inefficient, proposals to re-appropriate unused water rights have met with significant opposition because it was considered by some to be an unconstitutional infringement of property rights (Bauer 2004; Donoso 2006). Options considered include a tax on all water rights (offset by a corresponding decrease in the land tax) and a fee on unused water rights. The Chilean Congress accepted a proposal in 2005 to tax unused water rights to create an economic disincentive against hoarding (Donoso 2006).

Performance of the Chilean water code has been variable with a key conclusion that water rights transactions are uncommon in most parts of Chile, and that the great majority of transactions took place within the agricultural sector rather than involving inter-sector reallocation (Bauer 2004). Water transactions are more prevalent in parts of the country where water is scarce and thus has greater economic value (Bauer 2004; Donoso 2006). As noted by Bauer (2004), some observers have suggested that the lack of water rights transactions showed that the existing allocation of water resources was already efficient. Water rights owners rarely sell used or surplus water rights, but instead tend to hold onto them for protection against occasional drought years or in anticipation that they will increase in value over time (Bauer 2004).

Problems with the water law independent of market allocation include (Bauer 2004; Donoso 2006):

  • unavoidable transaction costs related to modification of distribution infrastructure,

  • externalities; negative effects on third parties, particularly the loss of water to downstream farmers dependent on spillover water, and the environment, and

  • uncertainties over the availability of water, such as inter-year variability in discharge.

Problems related to market allocation of water include:

  • lack of timely and adequate information on water rights,

  • uncertainty over resource availability (e.g., are the purchased water rights fully available),

  • unavoidable transaction costs (e.g., investigations, legal, administrative),

  • speculation and hoarding; obtainment of water rights by parties who will not use the resources, which creates an inefficient use of water from a societal perspective, and

  • absence of a clear and effective mechanism for resolving disputes.

Bauer (2004) argues that Chilean water law is not compatible with IWRM because it fails to address elements such as social equity, coordination of multiple uses, river basin management, resolution of conflicts, environmental protection, and non-consumptive water rights. Specifically, Bauer (2004, p. 133) observed that:

Because the Chilean approach to managing water as an economic good puts all the emphasis on water as private good and tradable commodity, it is very difficult to recognize or enforce the other aspects of water as a public good.

A major challenge of the Chilean system is that by establishing water rights as private property and having strong constitutional and judicial protection of property rights, the water management system inherently has a low degree of flexibility.

8 Third Party Effects of Water Trading

Spillover or third party effects may result from water rights transfers, which need to be considered when developing water policy. Third parties include a range of economic, environmental, and social interests impacted by a transfer, but have a non-proprietary stake in the process. The Committee on Western Water Management of the United States National Research Council conducted a study of water transfer issues in the Western United States, focusing on third party effects (National Research Council 1992). The study is still germane to water transfers in general although the specific regulatory discussions are applicable only to the Western United States.

Third parties include (National Research Council 1992):

  • other water rights holders and users (e.g., loss of return flows),

  • agriculture (including businesses and farmers in area of water origin),

  • the environment,

  • urban interests,

  • ethnic communities,

  • non-agricultural rural communities, and

  • taxpayers.

A key observation of the National Research Council (1992) is that the primary parties in a voluntary water transfer (i.e., the buyer and seller), negotiate their own best interests and exercise control over whether or not the transfer will occur. Public policies must be concerned with the interests of third parties who stand to be affected by the transfer, but are not represented in the negotiations.

Considerable concerns have been raised about the economic impacts of water transfers. Transfers typically result in the transfer of water from rural to urban communities (Henderson and Akers 2008). The discontinuation of agricultural activities results in a loss of farm jobs and farm incomes, less agricultural business activity, and less household spending in the community, which effects non-farm related businesses (Office of Technology Assessment 1983; National Research Council 1992; Henderson and Akers 2008; Clayton 2009; Glennon 2009). The local tax base is affected by a decrease in economic activity and the transfer of land to non-taxpaying municipal ownership.

The discontinuation of farming operations can thus have a ripple effect throughout the local community. The indirect financial contribution of agriculture to the local economy may be equal to or several times greater than the value of direct crop sales. Where the transfer of water occurs locally, the change in the local economic base may be neutral or net beneficial, but there may still be people left behind, such a farm workers left out as the economy shifts away from agriculture (Office of Technology Assessment 1983).

The effects of economic dislocations from the transfer of water may be a highly contentious issue, especially if the water is transferred out of a community. Adverse impacts may be experienced at the point of origin, whereas benefits are accrued at the transfer location. Water may be the basis of present and future economic vitality and environmental amenities (National Research Council 1992). Local communities can lose the economic benefit associated with the water in its present (use) and possible future uses.

There is also a scale factor associated with water transfers in the sense that transfers can have a negative impact on local communities, but result is a greater net benefit to the state or country as a whole (National Research Council 1992). The question of the importance of rural community preservation is a social, political and economic issue for which there is no universal answer. There is no consensus in the value of rural agricultural communities (National Research Council 1992). Changes in the use of water are necessary and desirable in a dynamic society (National Research Council 1992). Community preservation concerns need to be weighed against overall societal benefits. One option to mitigate impacts of water transfers on local communities is that mechanisms be emplaced to compensate communities for transfer-related losses of tax base and that third party effects should be internalized as a cost of the transfer (National Research Council 1992).

There is also the basic social desirability issue of loss of agricultural production needed to feed a growing global population. Although there is little question that water use for agriculture generates less wealth than the use of the same volume of water to manufacture semiconductors or other industrial uses, there is a societal benefit in having affordable food. A common theme envisioned for transfer of water is a regulated market with governmental responsibility to protect third parties from potential harm caused by water transfers and to ensure that the transfers do not harm the environment (Glennon 2009). The National Research Council (1992) noted that the quest is for a balance point that allows for broader participation in decision making while not inhibiting desirable transfers.

Clayton (2006) proposed the following six elements in market-driven water transfer system, particularly where inter-basin transfer is involved:

  1. 1.

    incorporation of public review,

  2. 2.

    simplification of water transfer protocols and legal systems to ease trading, reduce costs, and increase flexibility,

  3. 3.

    incorporating expiration dates for traded water,

  4. 4.

    the use of water banks, particularly for water trades across state lines,

  5. 5.

    requiring that a useable portion of the water remain associated with its previous use, and

  6. 6.

    including externalities (e.g., environmental protection, aesthetic and recreational values) in the pricing of water.

Inter-sector transfers of water can be performed through a free market system or may be implemented as an element of governmental water management policies. In this case national priorities are set concerning which sectors will be given priority. For example, within Israel, the policy is that domestic and urban uses have the first priority for water, followed by industrial uses and finally agriculture (Faruqui 2001b). Agricultural needs are increasingly being met by urban wastewater reuse.

Intersector transfers must also give consideration to cultural values. Preservation of rural agricultural communities may be given a higher priority based on cultural issues than can be justified based on their contribution to the gross national product. Small towns in agricultural land areas may be especially harmed by the transfer of water to urban areas. Some political systems may give disproportionate power to farming areas. For example, the Senate of the United States has two members from each state irrespective of their populations. Low population farm states have a disproportionate influence in the Senate relative to their population, than the more densely populated more urban states. Religious values and teachings may also be a consideration for intersector transfers of water. In theory the relocation of water from agriculture to domestic use should be easier to support in Muslim countries than in non-Muslim countries because of the primacy in Islam of water use for domestic purposes (i.e., the right to quench thirst and the right and requirement to be clean; Faruqui 2001b).

Brooks (1997) claimed with respect to the Middle East that the combination of modern market approaches with their emphasis on efficiency and traditional institutional approaches, with their emphasis on equity, will prove superior in almost every way to any of the mega-projects for water supply under consideration in the region.

9 Subsidies

Very few would argue that water should be treated entirely in a free market manner in which those who cannot afford to pay for water should be denied it. Some subsidization is necessary. It also recognized that subsidies and other types of government support must be geared to protecting those at the bottom of the income scale and that “no serious industry observer or market advocate would argue with this assertion” (Maxwell 2009, p. 28).

The subsidization of water for irrigation and urban use is ultimately based on political and social grounds. Subsidization occurs when users do not pay the full cost to construct and operate the water supply and irrigation systems. When they receive energy below cost, groundwater pumping is encouraged. In many areas, irrigation systems are built, maintained, and operated by public agencies, with irrigators charged next to nothing for these services (Postel 1993). This reduces incentives for conservation and increased water efficiency and allows water to be used for low-value crops, which would not be economically viable if the farmers had to pay the full cost of the water. For some crops, the value added by irrigation is less than the average cost to supply the water (Brooks 1996). However, Faurés et al. (2007) observed with respect to subsidized investments in irrigation, that the systems need to be reviewed within the context of rural development, rather than simply agricultural development. Increases in farmer’s incomes fuel the rest of the rural economy.

A critical point is that subsidies are implemented when society (or at least the part of the society that decides on the issue) places a greater value on a particular use of water than its market value. Otherwise, there would be no need for a subsidy. The major problem is that when subsidies are used to artificially depress the price of water (or any other good), then that water will be consumed in quantities that are greater than economically efficient quantities. In elementary economics, a commodity that is supplied too cheaply will sooner or later need to be rationed by more or less arbitrary means. Those who are fortunate to be provided water will use it excessively and wastefully (Winpenny 1994). There is little economic incentive to conserve water. However, effective water pricing, particularly for irrigation water is a highly sensitive issue, particularly in low income countries, where agriculture still dominates the economy and most farmers have limited incomes. Maintaining social stability is given a greater value than the market value of water.

Stile (1996) noted that with respect to developing countries, investment in more efficient irrigation and improvement in irrigation water distribution are capital intensive and almost always require some degree of public investment regardless of the eventual beneficiary. In Africa and other developing areas, the true costs of irrigation development are rarely passed on to farmer, partly at least because so many irrigation projects are funded by donors. Farmers may not be able to pay the full cost of water because they may not be able to recover fair value for the crops due to price setting on food, which is implemented with the goal of protecting consumers. In this case, there may be both a subsidy for farmers in providing the water at below market value, and an indirect “tax” on farmers for keeping food prices artificially low, below market value.

Subsidization can be justified for domestic water supply. It is a generally accepted development goal that water to meet the basic needs of individuals and communities should be made available at prices consistent with the economic capacity of respective communities (Allan 2001). The initial development of the basic water infrastructure in much of Europe (and other developed areas) involved massive government subsidies (i.e., investments that were not paid for directly through water rates) (Rahaman and Varis 2005). It is absurd to believe that the construction or substantial improvement of a comparable water infrastructure can be implemented in developing countries without some form of subsidies.

An important point raised by the Global Water Partnership (2000) is that subsidies should be transparent and it should be recognized that all subsidies have to be paid by someone. Subsidies have very often been hidden from public view, because they would otherwise not be politically acceptable. For example, many water projects in the Western United States represent massive subsidies to farmers because the water provided by these government-financed projects has been sold to them a fraction of its true cost and funded via congressional funding through the U. S. Bureau of Reclamation (Reisner 1986). The true economics of these water projects was commonly obscured to make them politically acceptable.

10 Privatization of Public Water Treatment and Distribution Infrastructure

An important distinction is made between ownership of water and ownership and management of municipal water supply and distribution infrastructure. A question that is receiving more interest in recent years is whether water and wastewater utilities should be publically or privately owned and operated. Both private and public water utilities operate in the United States and, from the experience of the authors’ there is little difference between the quality of services provided by both. Yet in many areas of the world, privatization of water is a highly controversial issue.

The Committee on Privatization of Water Services in the United States of the National Research Council (CPWSUS 2002, p. 57) observed that

Private organizations do not necessarily operate efficiently, nor are they inherently more efficient than public organizations. By the same token, public organizations do not always deliver on their promises. The point is that neither public nor private organizations automatically entail “effectiveness.” Well-run and poorly run organizations exist in both sectors.

There are many permutations involving private ownership and operation of water and wastewater utilities. Privatization of water utility services can take a wide variety of forms from providing specific services (e.g., billing or some maintenance activities) to outright ownership of the water supply and distribution infrastructure. There are four basic types of utility privatization (CPWSUS 2002):

  • outsourcing of specific support services, such as laboratory services, billing, meter reading, some maintenance activities, and vehicle maintenance,

  • outsourcing of the full operation and maintenance of the water utility,

  • design, build, and operate contracts for new, expanded, or up-dated facilities, and

  • outright sale of utility assets to a private company.

A common type of privatization is concessionary agreements in which a private company rents the infrastructure from the public sector and undertakes to maintain the system and finance any improvements in return for being allowed to collect payments from users (Segerfeldt 2005). The performance requirements of concessionary contracts may include requirements to supply water to the poor, maintain infrastructure, and meet water quality and environmental objectives. Concessionary contracts can also provide public oversight of water rates. Privatization does not imply that the private utility will have a free hand to set water rates. Private companies typically fall under the regulatory oversight of local public utility commissions or other government agencies, which have the authority to review and approve or reject proposed rate increases. This process can be contentious and lead to contractual disputes.

The arguments presented in support or against privatization of water utility services often reflect strong philosophical biases of authors with selected anecdotal evidence presented in support of positions. Maxwell (2009, p. 26) noted:

the participants in this debate usually talk past one another and fail to move the discussion forward; indeed, such forums often serve as little more than soapboxes for airing the same old arguments between the advocates and opponents of privatization.

Opponents of privatization commonly object to privatization as a matter of principle against corporations profiting from need of the people for water, which is considered to be a basic human right (Segerfeldt 2005). It has been suggested that private companies have little incentive to maintain infrastructure, protect the environment, provide service to the poor as well as the rich, and to monitor for water quality (Glennon 2009). The alternative thesis that has been proposed is that private water corporations are more likely than government bureaucracies to handle water with care. Profit motives are suggested to give strong incentives to conserve water, provide services to customers, and reduce waste (Segerfeldt 2005). Segerfeldt (2005) argued that the strongest benefit of private involvement is the profit motivation to reach as many users as possible. However, it is important to also recognize that it is often unprofitable to serve some areas because of low population densities or inabilities to pay. In a free market, the natural tendency is to harvest the ‘low-hanging fruit’ and decline to provide unprofitable services. It is possible that private contractors might achieve cost savings (i.e., economic efficiency) by cutting staff, not making necessary investments in operations and maintenance, and reducing necessary long-term investments (CPWSUS 2002).

Privatization is not the same as competition. Once a long-term contract is signed, competitive pressures to operate efficiently and meet public expectations are gone (CPWSUS 2002). Competition is limited to the period when competitive bids are being accepted.

The strongest argument in favor of privatization is that can provide needed resources in areas where public systems cannot provide adequate water supplies or cannot do so in an economical manner. There is no practical reason to consider privatization in areas where the public water system has the financial and technical resources, ability, and desire to cost-effectively provide safe water to the entire local population. Privatization is considered where public systems cannot provide what is considered to be adequate water service or does not have the financial resources to meet current and future system needs. The major advantage of privatization is that it can provide much needed access to capital, managerial competence, and technical expertise and experience that are not otherwise available (Segerfeldt 2005). Privatization or long-term Design-Build-Own-Operate (DBOO) or Design-Build-Own-Operate-Transfer (DBOT) contracts allow private companies to bring innovation into the operating world and can lower the cost of providing potable water to municipalities (e.g., large desalination facilities in the Middle East or North Africa). The ownership transfer option DBOT can be used both to obtain industrial innovations in design and as a financing mechanism to allow the expansion of utility systems where public funds are inadequate. Also, financial guarantees can be obtained from third parties to protect successful bidders from default losses, particularly in developing countries (e.g., World Bank, certain NGO’s).

Privatization results in a reduction in local control, which can have both beneficial and negative impacts on the local communities. Private companies may be less susceptible to political pressures. The primary objective of private utilities is to provide a reasonable return for the owners or shareholders. Economic efficiency may be sacrificed in the public sector in order to achieve other community goals such a local utility jobs and supporting local suppliers (CPWSUS 2002). Privatization can also result in a loss of local capabilities and expertise should a decision be made in the future to transfer the entire utility or functions back to the public sector (CPWSUS 2002).

Privatization often results in an increase in the cost of water as private companies must recoup their costs and make a profit (unless innovation in treatment processes reduces cost). Public systems are commonly subsidized to some extent and revenues collected from water sales do not cover system capital, operations, and maintenance costs. In the absence of government subsidies, costs must rise to meet expenses. However, it is important to recognize that people without water main service are paying more for water today than they would if connected to a distribution network. The higher costs are direct costs from purchasing water from vendors, and indirect costs associated with the time and effort required to secure water and the health impacts of poor quality water (Kadouri et al. 2001; Segerfeldt 2005). A realistic water price would allow for reinvestment into water supply and distributions systems to serve the poor that have no service. However, a common thread in almost all developing countries is the urban middle and upper class areas are more likely to be served and also have more political clout than the poorer members of the society. Those who are fortunate to receive subsidized service are often unwilling to pay greater rates to cover the costs of expanding the systems into poorer areas.

The success of the regulating monopolies, such as private water utilities, depends upon the strength of political institutions responsible for their oversight. Privatization may be less successful in developing countries because ineffective or corrupt governments lack the capacity or will to adequately regulate the private sector (Glennon 2009). Privatization is not a panacea for financial woes and decayed infrastructure (Glennon 2009).