ROLE AND USE OF ECONOMIC INCENTIVES IN ......2Ariel Dinar, Lead Economist, Rural Development...

ROLE AND USE OF ECONOMIC INCENTIVES IN IRRIGATED AGRICULTURE

Dirgha Tiwari1 and Ariel Dinar2

1Dirgha N. Tiwari, Dr.Eng., Senior Resource and Environmental Economist, PO Box 12609, Kathmandu, Nepal, Tel: (977 1) 273090, Fax: (977 1) 220143, E-mail: [email protected]. 2Ariel Dinar, Lead Economist, Rural Development Department, World Bank, 1818 H St. NW, Washington DC, 20433, USA, Tel: 202 473 0434, Fax: 202 614 0793, E-mail: [email protected].

The views in this report should not be attributed to the World bank.

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TABLE OF CONTENTS

Acknowledgements.........................................................................................................................iii Executive Summary........................................................................................................................iv Introduction......................................................................................................................................1

Towards a Paradigm Shift ...........................................................................................................1 Scope and Organization of the Paper.......................................................................................3

Various Faces of WUE and What Does it Mean? ...........................................................................3 Technical Efficiency....................................................................................................................3 Ecological or Environmental Efficiency of Water Use ...............................................................4 Other Faces of WUE....................................................................................................................5

Basic Concepts.........................................................................................................................6 Practical Issues in Implementation..................................................................................................6

Basic Concepts.........................................................................................................................7 Practical Issues for Implementation.................................................................................................7

Basic Concepts.........................................................................................................................8 Practical Issues for Implementation.........................................................................................8 Basic Concepts.........................................................................................................................9

Practical Issues for Implementation...............................................................................................10 Other meansCapacity.............................................................................................................11 Ownership of Resource..........................................................................................................11

SCOPE OF POLICY INTERVENTION.......................................................................................12 Policy Intervention at the Regional Level .................................................................................12 Policy Intervention at Sectoral Level ........................................................................................13

Practical Applications and Scope of Policy Intervention..............................................................14 Policy Intervention at the Inter-sectoral Level ..........................................................................14 Policy Intervention at the Economywide Level.........................................................................15

ROLE OF ECONOMIC INCENTIVES IN MOTIVATING IMPROVED WUE ........................17 General Concepts and Basic Issues ...........................................................................................17 Prices..........................................................................................................................................17 Subsidies ....................................................................................................................................19 Taxes ..........................................................................................................................................20 Quotas ........................................................................................................................................22 Ownership/Rights ......................................................................................................................23

REVIEW OF ACTIVE BANK IRRIGATION PORTFOLIO: USE OF ECONOMIC INCENTIVES ................................................................................................................................24

Methodology..............................................................................................................................25 Data and characteristics of the portfolio ....................................................................................25 General results ...........................................................................................................................26

Descriptive statistics ..............................................................................................................26 Table 6.2: Distribution of incentives per project.......................................................................26 Detailed analysis of the various incentives................................................................................28

Water Prices/fees ...................................................................................................................28 User Participation ..................................................................................................................29

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Capacity Building ..................................................................................................................29 Transfer of Assets ..................................................................................................................29 Some non-specific incentive examples..................................................................................29

Conclusion on the World Bank Portfolio Review .....................................................................30 GENERAL CONCLUSIONS, LESSONS LEARNED AND FUTURE DIRECTIONS..............30

General Conclusions ..................................................................................................................30 Lessons Learned ........................................................................................................................30 Future Directions: Some Implications for the Lending/Donor Agencies ..................................31

REFERENCES ..............................................................................................................................32 Stiles, G. (?) From Demand-side Management, Conservation, and Efficiency in the Use of Africa's Water Resources, SADC Energy Management Project, Harare, Zimbabwe. (web-page?).........................................................................................................................................38

APPENDIX A-1.0 .........................................................................................................................40 APPENDIX A-2.0 .........................................................................................................................42 APPENDIX 2.0 (Boxes) ................................................................................................................43 APPENDIX 3.0..............................................................................................................................45 APPENDIX 4.0 (Figures) ..............................................................................................................48 APPENDIX 5 (Texts and Figures) ................................................................................................51 CASE EXAMPLES .......................................................................................................................65

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ACKNOWLEDGEMENTS

This paper is intended for the policy makers and practitioners in developing countries involved in water allocation decisions and policy settings. With an aim of promoting better understanding and making a paradigm shift towards improving water use efficiency in irrigated agriculture as a “new source” of wa-ter augmentation. The authors would like to thank Jacob Burke, Jan Poulisse, and Kenichi Yokoyama for their detailed written comments and suggestions on a previous version of this paper. The work on this report was partially funded by the Irrigation Institution Reform Window of the Bank-Netherlands Water Partnership Program.

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EXECUTIVE SUMMARY

In the face of growing water scarcity, increasing competition for water across different economic sectors, and escalating costs of additional sources of water augmentation, improvements in water use efficiency (WUE) is largely seen as a “new source” of water for matching the increased demand of water. The call for improvements in WUE though is not a new proposition, past attempts toward this direction have mainly been engineering or technology driven. Efforts toward improving WUE however, involve a wide range of means including economic, institutional, agronomic, and hydrological and ecological con-straints. This requires better understanding of the cause and effect links among these various dimensions and adoption of an integrated approach and thus demands a paradigm shift in managing irrigated agricul-ture. While studies on measures for improving technical efficiency of water use and the use of economic incentives are common, studies linking the various faces of WUE and both monetary and non-monetary measures are very rare. In this context, this paper attempts to provide some answers on: How to improve basic understanding and knowledge of WUE and the links between these efficiency measures and eco-nomic incentives among the technical and policy makers for making a paradigm shift toward addressing the increased threat to global food security and poverty? And more specifically;

• What are the various faces of WUE that needs to be taken into considerations for a paradigm shift from conventional and more technological oriented approach to the demand-based and integrated ap-proach of improving WUE?

• What scope exist for policy intervention for improving WUE at different levels of spatial and institu-tional hierarchy?

• What could be the role of economic incentive measures in motivating improved WUE and also in helping the small holders and rural poor?

• Related to the specific experiences at the project level in the past, to what extent the Bank - assisted projects have addressed the concerns over increasing WUE with adoption of economic incentive measures and what lessons could be drawn from the past experiences towards improving WUE using economic incentive measures?

In an effort to address these emerging concerns, this paper defines various faces of WUE and discuss on how the various economic incentive measures could be used for improving them at different level of pol-icy interventions. A review of the active Bank portfolio projects on the use of economic incentive meas-ures is also presented. The key findings and lessons to be drawn from this paper are:

• First, there exist a wide range of efficiency measures other than technical efficiency, and the scope of policy intervention depends on the specific policy target aimed at improving technical efficiency or a range of efficiency measures using an integrated approach. This further indicates that WUE need to be defined and adopted in a broader term considering technical, economic and ecological efficiency of water use. Likewise, the nature and importance of improvements in different faces of WUE should determine the scope for policy intervention in a particular region or the project case, and careful inte-gration of economic measures is needed to improve overall WUE.

• Second, it is clear that economic incentives will have better impact when they are grouped and com-plement each other and it is being more and more evident that economic measures are an effective policy instrument that may motivate all layers of the sector—government, suppliers, and users. This also requires that developing countries should strengthen existing weak regulatory and institutional structures in order to provide a sound basis for the adoption of economic incentive measures.

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• Third, it is also evident that the emerging option of delegation of responsibility, to user groups, of al-locating water, collecting and handling fees, and even purchasing necessary equipment, is used more frequently in water sector reforms. While this is a welcome move, and needs to be continued under “water management transfer” programs, however, the question of efficient allocation of scarce water resources will not be solved just focusing on these aspects. Attention should also be shifted towards the policy integration at the sectoral and economy-wide level rather than only through irrigation sub-sector or water sector review as practised in the past.

• Fourth, the review of the active Bank’s irrigation and Drainage (I&D) portfolio revealed that eco-nomic incentives are not adequately used in Bank projects, many of the incentive measures adopted such as water pricing mechanism are not based on the user pays principle and how far these incentive measures adopted will help in promoting various facets of WUE is also uncertain in many of these projects. From the view point of international lending agencies, both the institutional reforms and gradual introduction of economic incentives with major focus in policy intervention at the inter-sectoral level should be tied with the lending programs on land and water management.

• Finally, irrigation water subsidies continue to be a popular means of pleasing smallholder farmers in most of the developing countries. Studies however, have shown that the large or medium size land-holders and the agribusiness sector are taking more advantage from such subsidies rather the rural poor. The lesson learned is that developing countries can overcome from the poverty trap and make efficient use of water resources by eliminating existing subsidy and introducing economic incentive measures along with development of mechanisms for recycling part of the revenue to motivate the smallholders for the adoption of sustainable water management and agriculture practices and com-pensate for the societal benefits they generate from these activities.

INTRODUCTION

Irrigated agriculture consumes between 60 - 80 percent of the total water use, and contributes about 38 percent of the global food production. It has played a major role in generating employ-ment opportunities in rural areas and for providing food to the urban poor at relatively cheaper prices. Globally, the irrigated agricultural lands have increased almost by 2.4 percent in the sev-enties to 1.4 percent during the eighties and late nineties. It is projected to increase further by 0.4 percent per annum for the next 34 years (base year 1995/96, FAO, 2000). This indicates that the irrigation sector uses a large share of global water, as also that the demand for irrigation wa-ter will continue to rise in the years to come. On the other hand, while the world population has doubled in the last four decades, water use for domestic and industrial purposes has increased almost by three-fold during the same period (CSD, 1997) and the competition among water users is increasing.

Managing water supplies, on the other hand, is becoming increasingly complex due to increased length of water stress period, droughts, decreasing water quality, escalating cost of augmentation and transportation of fresh water resources, etc. The increased vulnerability in rainfall patterns and distribution, depletion of ground water resources, drought-driven crop failure and the resul-tant issues about food security for a rapidly growing population, and health risks due to unsafe water sources also have given rise to new eco-conflicts (Falkenmark, 1997). Two more emerging challenges - globalization and impact of water resources use upon agriculture and trans-boundary conflicts in sharing the water resources - have been profound in recent years. The challenge that the irrigated agriculture is likely to face in the coming years is: How to maintain and increase production and enhance water productivity in the face of growing water scarcity and limited ac-cess for its use in agriculture (Braden and van Ierland, 1999).

How can this situation be overcome at relatively affordable costs - including those relating to hunger and lack of safe drinking water in the developing countries - and solved in the years to come? One of the solutions to managing growing water crisis is to increase current water use ef-ficiency (WUE), and promote efficient allocation of available water resources among different users. Despite the large contribution of irrigated agriculture in reducing the problem of hunger, WUE in irrigation sector is generally considered very low in deve loping countries, with national averages at the range of 25-50 percent. Increase in WUE in irrigated agriculture alone could meet about 50 percent of the projected increase in total water demand till 2025 (Seckler, 1999) and water conservation in agr iculture is being looked upon as a new 'source' of water (Caswell, 1991).

Towards a Paradigm Shift

The call for increasing WUE is not a new proposition. Yet past attempts toward this direction have mainly been engineering or technology driven. Efforts toward improving WUE involve a wide range of means including economic, institutional, agronomic, and hydrological and eco-logical constraints. It also requires an understanding of the cause and effect links among these various dimensions, adoption of an integrated approach and demands a paradigm shift in manag-ing irrigated agriculture for various reasons:

First, irrigation water is now considered an economic good, a means for maintaining food secu-rity and generating rural employment opportunity and poverty alleviation, and improved WUE as

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a "new source" of water to meet the growing demand for food. Studies also have shown that the water crisis can be partly solved by increasing WUE, and there is considerable scope for improv-ing efficiency of water use through carefully managed irrigation systems (Falkenmark and Lindh, 1993; Alexandratos, 1995). Second, the increased emphasis on the socio-technical ap-proach in water management in the eighties and nineties, has led to some fruitful results. Water user groups are increasingly playing an essential role in collecting water fees, and overseeing op-eration and maintenance (O&M) of canal systems. Obviously, the time has now come to change users' behavior for promoting WUE and strengthening the facilitating role of users' organizations for achieving this goal.

Third, the implementation of economic incentive measures and shift in irrigation technology in some developed countries, have helped to save large amounts of water and have resulted in higher irrigation efficiency, estimated to be between 70-80 percent1 . The WUE is considered di-rectly proportional to the prices charged for water servicing as rising prices leads to increased at-tention to more efficient water use generating powerful incentives for increasing WUE (Tate, 1994).

Fourth, both the increasing costs of provision of water services and labor may force a shift in land management techniques such as from transplanted to dry seeded rice, leading to large reduc-tion in water use. If water charges are designed to reflect these costs, there could be large reduc-tions in water use, especially in the rice producing countries of South and Southeast Asia.

Fifth, increased agriculture trade liberalization (ATL), which has resulted in a shift in the com-modity trade and production patterns, has increased concerns over subsidies for irrigation water. Analyses have shown that trade reforms combined with institutional reform in the water sector, such as water pricing reforms, or promotion of water market, could prove to be more welfare in-creasing (Diao and Roe, 2000).

Finally, despite all this, future prospect is not very rosy. Since a majority of population in the developing countries still lives below the poverty line, efficient management of irrigation water is necessary to boost agriculture production and generate rural employment opportunities. There is a need for designing economic incentives that also address the concerns of the poor segments of the population who rarely have the capacity to take advantage of agr iculture and trade-based reforms and compete in the market. However, if properly designed and implemented, measures towards improving WUE and improved WUE could also help smallholder farmers and rural poor in different ways. These include: i) alternative employment opportunities in construction and op-eration of water conserving technologies, ii) allocation of water rights and rights to sell the wa-ter, and iii) subsidized credit facilities for adoption of water conserving technologies.

Therefore, the major challenge is: How to improve basic understanding and knowledge of WUE and the links between these efficiency measures and economic incentives among the technical and policy makers for making a paradigm shift toward addressing the increased threat to global food security and poverty? More specifically, there are four major aspects to this question:

What are the various faces of WUE that needs to be taken into considerations for a paradigm shift from conventional and more technological oriented approach to the demand-based and inte-grated approach of improving WUE?

1 For example, see Casewell (1991; Appendix A-3.1)

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What scope exist for policy intervention for improving WUE at different levels of spatial and in-stitutional hierarchy?

What could be the role of economic incentive measures in motivating improved WUE and also in helping the small holders and rural poor?

Related to the specific experiences at the project level in the past, to what extent the Bank - as-sisted projects have addressed the concerns over increasing WUE with adoption of economic in-centive measures and what lessons could be drawn from the past experiences towards improving WUE using economic incentive measures?

Scope and Organization of the Paper

In this context, this paper aims to address some of the above concerns for promoting better un-derstanding of the links between various facets of WUE, the scope and level of policy interven-tion required, and economic incentive measures for improving WUE. Section 2 highlights the various water use efficiency terms - technical, economic and ecological efficiency of water use in irrigated agriculture. How can these different facets of WUE be improved? This issue is dis-cussed in Section 3. Section 4 highlights the scope of policy intervention at different leve ls of hierarchy for improving WUE. Finally, Section 5 briefly outlines the basic concepts and means of implementation of various economic incentive measures for improving WUE. Conceptual framework showing the cause and effect links, theoretical explanations of the concepts and prac-tical applications of economic incentive measurers in different countries and regions are pro-vided in the Appendix.

VARIOUS FACES OF WUE AND WHAT DOES IT MEAN?

In simple terms, water use efficiency in an irrigation system refers to the ratio of water volume actually applied at the crop root zone to the total water volume entered into the main delivery system. Traditionally, the efficiency in water use has been looked upon from a technical point of view (Omezzine and Zaibet, 1998). The technical efficiency used in engineering design, and economic efficiency used in measuring the overall rate of economic returns from the irrigation system, provide only a partial basis of measuring efficiency and implementing means to improve both. The term "efficiency" in irrigation water use thus should not be limited to the technical ef-ficiency or to the water conveyance and distribution (Kirpich et al., 1999). In the face of grow-ing water scarcity and changing patterns of water demand, there is a need for redefining effi-ciency and understanding the existing links among various faces of WUE.

Technical Efficiency

The technical concept of efficiency of irrigation water use is usually measured by the ratio be-tween total water supplied by the system to total water taken by the plant. Technical efficiency differs from the overall concept of WUE in that it is measured in terms of the physical layout of the canal systems such as conveyance, distribution and application efficiencies. These follow accounting of the loss of irrigation water due to seepage and percolation, and evaporation during conveyance and water use at the farm level. The irrigation efficiency of the major surface irriga-tion systems of the world with flood systems is estimated to be very low, between 37-50 percent (Appendix Box A-2.1).

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These various measures of technical efficiency - conveyance, distribution and application effi-ciency - are shown in Fig. A-2.1 (Appendix) and are mainly influenced by the nature of topogra-phy, type of soils, materials used in the canal lining and methods of water application. The eco-nomic implication is hence: how to increase the existing low level of technical efficiency of irri-gation systems by introducing the use of economic incentive measures at various levels of hier-archy of water conveyance and applications?

Economic Efficiency

The economic efficiency of irrigation water use is measured in terms of crop output per unit of water applied or overall financial returns in terms of net benefits from the project. Economic ef-ficiency usually measured in terms of cost-benefit ratio, has long been used in investment deci-sion making, which seeks to derive maximum return from the irrigation system over the project life period. It also does include impacts by price policies and incentives for farmers to move to high value crops. The definition of WUE itself is rooted in the concept of economic efficiency (Tate, 1994) which implies that water needs to be used with maximum possible efficiency and could be defined in various ways:

• In general, economic efficiency indicates the Pareto optimality condition (see Appendix A-1.0 for definition of terms) and considers not only the private costs and benefits but also the internalization of the non-financial social costs and benefits.

• Economic efficiency also refers to the maximization of overall socio-economic net benefits from different water using sectors, and seeks to minimize inter-sectoral and intra-sectoral socio-economic opportunity cost (Mohamed and Savanije, 2000). The term also applies to policies involving the re-allocation of water between different users, e.g., within agriculture sector, or from agriculture to urban or environmental use (FAO, 1995).

• From the sustainability viewpoint, the concept of economic efficiency could be defined in terms of weak sustainability considering water as a "critical capital" (Turner, 1993). To some extent, increasing investment in water augmentation could also minimize the scarcity of water.

• Finally, economic efficiency also refers to the productive efficiency, which indicates a cho-sen trade-off between production and conservation with least cost (Young, 1997). At the ba-sin level, the productive efficiency refers to the percentage of catchment yield actually ap-plied to productive uses rather than the part lost to evapo-transpiration or unrecoverable ground water pollution (Winpenny, 1997).

The term 'economic efficiency' thus needs to be considered in a broader perspective and should include factors involving technical efficiency, opportunity cost of water, and externality costs generated by the irrigated agriculture (Tiwari, 2000a).

Ecological or Environmental Efficiency of Water Use

The term ecological efficiency in case of irrigated agriculture is deeply rooted in the concept of environmental sustainability. It implies that available water resources must be managed in a way so as not to reduce opportunity for potential use by the future generations for various ecological reasons. In operational terms, ecological or environmental efficiency indicates that available wa-ter should be allocated in such a way that helps to meet the need for consumptive use of water

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without having adverse effects on the ecological health in the surroundings. From economic viewpoint, the lost opportunity benefit of water in terms of impacts on ecological health of water transfer also need to be considered while making water allocation decisions for various reasons:

• First, although the term WUE itself is widely perceived as a beneficial reduction of water use or in terms of conservation of irrigation water, it usually does not take into consideration of the negative impacts of water withdrawal and use. For example, one can refer to the impacts on the wetlands or aquatic ecosystems from the diversion of river water. The diversion of large amounts of river water for irrigation purposes also affects ecological functions such as aquatic life downstream.

• Second, water used for irrigation purposes also results into negative impacts such as in-creased water logging, salinization, and soil erosion. These are also referred to as "external-ity costs" as these types of costs are not usually incorporated into the economic price of irri-gation water.

• Third, there is a need for recognizing the ecological limits of water use. For example, in case of ground water use, although water is used more efficiently, the total water withdrawn may exceed the sustainable supply of water.

• Fourth, the increasing ecological degradation, such as wetland and upper watershed degrada-tion and excessive withdrawal of groundwater, could also impact on the availability of water for future use in agriculture.

The implication of environmental measure of efficiency is that the provision of economic incen-tives should not only be limited to water conservation, but also needs to be incorporating eco-logical concerns in a given agro-ecological setting.

Other Faces of WUE

Besides, there are some other concepts of WUE. These are end-use efficiency and productive ef-ficiency often related to on-farm water use, operational measures of efficiency such as institu-tional efficiency, and finally, temporal measures of efficiency such as static and dynamic effi-ciency. These various faces of WUE are defined and used in different context under different agro-ecological settings (Box A-2.2). The reported irrigation efficiency or water loss figures in the developing countries (Box A-2.1) indicate that many irrigation systems are performing poorly with respect to conveyance and distribution. Therefore, raising WUE through reduction in water losses could substantially increase water conservation. How Water Use Efficiency Can Be Improved?

Improvements in the WUE involve measures that directly help to reduce different types of water loss and improve the handling of water at various levels and the decision regarding their best use. Various levels of decision-makers can be approached. Farmers' behavior can be affected in order to maximize the returns from or to minimize the waste of scarce irrigation water. On the other end, water suppliers have their own list of possible acts to WUE improvements, which imply bet-ter management of reservoirs, and coordination efforts in water supply scheduling.

As has been argued so far, WUE is affected by many factors, some of which are exogenous to the decision maker. Water loss due to evaporation from open channels, wind drift, bare soil and weeds is usually responsible for 20-30 percent of total water loss. Various factors such as sur-face losses, canal flow not applied to the field, runoff from the field, and outflow from drains,

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etc. are responsible for water loss. These factors are mainly influenced by agro-ecological char-acteristics, type of technology and methods of cultivation practiced by farmers, socio-economic factors and organizational effectiveness, etc. (Carter et al. 1999; Omezzine and Zaibet, 1998) and efforts towards reducing water loss and improving WUE thus require an integrated approach combining these various aspects. In his recent review of Asia’s Irrigation Management, Easter (2000) claims that lack of incentives for efficient water use have been an issue for many years. Easter adds that although the issues were identified, and proper policies for reform were de-signed, the implementation of the policies was delayed because of the the high transaction costs associated with f the reforms.

Farm-level vs. Water-supplier Level

Basic Concepts

Various agronomic, technical, managerial and institutional options are available and applied for improving WUE at the farm level. These include introduction of crop husbandry, adoption of cropping strategies that maximize crop area during periods of low evapo-transpiration, and adop-tion of practices that increase effectiveness of rainfall. Introduction of more efficient irrigation methods such as drip irrigation that reduces soil evaporation, and better use and management of saline and wastewater have also helped to enhance irrigation efficiency (Batchelor, 1999). How-ever, the changing patterns of water demand and conflicts in water use, climatic variability and uncertainty, and reported figures on water losses, all indicate that localized efforts at the farm level alone cannot produce an optimal strategy for improving WUE. First, although the adoption of efficient technology could improve WUE at the farm level, the extra water saved would not be readily available in other parts of the basin if only at the farm level is considered. Second, the adoption of an integrated approach to improving WUE at the basin-wide level also addresses many other inter-related problems and constraints that are not so apparent at the farm level (El-Beltagy and Oweis, 1998). For example, if reliable supply is not assured, farmers will be less likely to improve their field level WUE. Finally, water losses in reservoir systems and degrada-tion of water quality in the river are also drawing wide attention2 and efforts in improving WUE and need to be extended to the river basin/water-supplier level.

In addition, efficiency gains at the field level would make little sense, unless there are efficiency gains in the supply channel as a whole and there is also opportunity for making use of saved wa-ter for higher economic gains. Further, efficiency gains in irrigated agr iculture have to be achieved at the level at which they make a difference in reconciling competitive uses (including downstream users, in-situ environmental services etc.).

PRACTICAL ISSUES IN IMPLEMENTATION

Some of the existing river basin/regional organizations, for example, river basin organizations in France, have been successful in implementing economic incentive measures such as allocation of quota system and charging water across sectors. Making a shift from farm to water - supplier

2 For example, in China the storage capacity of reservoirs has been heavily reduced due to sedimentation, which is

estimated in the range of 24 to 84 percent in seven small to large reservoirs. In Africa, sediment yields in major rivers vary from 14.6 ppm to 49.4 ppm (Biswas, 1990). Degradation of upper watershed and reductions in sea-sonal river flow have resulted in low water volume in the reservoirs and reduced water velocity in the conveyance systems thereby increasing the potential for even higher loss of water.

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level or adoption of an integrated approach to improving WUE however, involves several com-plex issues for practical implementation of the concept:

• First, it expands the scope of the organizations mainly responsible for improving WUE at the farm level. For example, addressing issues at water-supplier level also involves the conflicts in sharing scarce water among different sectors and needs a decision on inter-sectoral alloca-tions.

• Second, evolution of the institution from one level to another is time consuming and necessi-tates proper budget allocations and manpower training. This increases administrative costs, which need to be weighed against the potential gains in the WUE with the adoption of integrated approach.

• Finally, transfer of lessons learned from existing river basin organizations to the developing countries, also depends on the nature of hydrology and ecological settings in these countries. Although creation of river basin institutions may ensure desirable results in improving WUE for example, in France, the need for correcting existing distortions and the institutional and legal arrangement for ensuring a success is very high (Nagaraj, 1999).

Therefore, an incentive system is useless unless it takes into account both the conditions under which the water supply and the demand are operating. Addressing only one of the equation vari-ables will end in ignoring the incentive by the party approached.

Technological Means

Basic Concepts

Where water loss during its conveyance, distribution, and application is significant, adoption of various types of technology and changes in water application and cultivation methods, and other management practices could bring about major differences. Adoption of modern irrigation tech-nologies such as low-volume irrigation as practiced in some countries like Israel, USA, India, and Western European countries presents one approach. Various techniques are available for saving irrigation water in rice fields, for example, reduction of water use during land preparation by reducing bypass flow such as due to fo rmation of cracks (Tuong and Bhuiyan, 1999). With the development of water saving technologies3, water users have found that they can decrease costs and increase output by adopting such technologies (Green and Hamilton, 2000). These various types of technologies and management options are widely used in different regions and countries (Box A-3.1).

Practical Issues for Implementation

The implementation of water fees combined with other fiscal incentives can encourage farmers to adopt water saving technologies (World Bank, 1993), but the technological efficiency of

3 Application of water saving techniques during crop growth include adoption of more water efficient methods of

rice establishment, and through improvements in water productivity with evapo-transpiration (ET), which can be achieved by agronomic manipulations of the rice crop. The change from the use of flooded irrigation systems to high-pressure sprinklers could reduce the evaporation loss significantly during the water application. Likewise, it is possible to increase infiltration and reduce wet surface area by excavating a column of soil from directly below the drip emitters and back filling it with coarse sand. This strategy has been used to reduce evaporation losses from 4 to 30 percent of the applied water (Meshkat et al., 1998, cited in Raine, 1999).

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available alternative measures, cost of adoption and incentive to conserve, all will determine the level of technological adoption.

• First, the resulting WUE from the same type of technology largely differs in different regions and countries. For example, the on-farm efficiency of spray irrigation in Israel and other parts of the Middle East is estimated between 75-80 percent. In hot, dry areas evaporation loss can be as high as 60 percent (Schwarz 1991) and efficiency is very low as in South Af-rica (Davies and Day, 1986, cited in Stiles, 1993).

• Second the capital- intensive nature of some technologies, such as drip and sprinkler systems, also constrain the use of similar means in the developing countries. For example, in some countries of Africa, such technologies are mainly imported from the Western European coun-tries and are very costly. Instead, irrigation technologies adopted in Asian countries could be more cost-effective and appropriate for African conditions (Palaniasami, 1998).

• Finally, the adoption of alternative technologies takes considerable time. The speed of tech-nological adoption also depends on the type of the farmers - whether they are early adopters, followers or laggards (Caswell, 1991). Nieswiadomy (1988, cited in Caswell, 1991) indi-cated that the likelihood of adoption of technologies increases as the prices of water and out-put increase or the quality of land declines.

Therefore, policies that provide incentives for adoption of water saving technologies should bare the physical, economic, and institutional environments in the localities in question.

Regulatory Means

Basic Concepts

Regulations are general rules or specific actions imposed by government agencies to enhance economic welfare through improved efficiency (Spulber and Sabbaghi, 1997). Both the regula-tory measures and regulating agencies have been created in the past as a remedy to the perceived failure of free market to allocate resources efficiently (Porteny, 1990). Limited government role and regulatory mechanisms such as enforcement of property rights through specific rules and regulations are also necessary for sound operation of the water market (see Box A-3.2). Regula-tory mechanisms are also essential for cont rolling use of groundwater; which otherwise could be over-exploited and could threaten the sustainability of a groundwater-based agriculture develop-ment in the region (El-Beltagy and Oweis, 1998) and provide a basis for integration of economic incentive measures. For example, although the quota or permit may be issued to each individual farmer, total abstraction may exceed sustainable supply and some form of regulation would be-come necessary for sustainable abstraction and use of groundwater and in maintaining water quality within the acceptable standard.


Government intervention through regulatory measures could be justified on economic efficiency grounds, if the beneficial outcomes outweigh the cost of regulation (Portney, 1990). Past experi-ences have shown that regulatory measures are less effective, involve high transaction costs, are usually rigid, and provide less incentive to change the users' behavior.

• First, the effectiveness of past regulatory measures is seriously questioned. For example, Goodstein (1995), mentioned the failure of the past regulatory measures for improving

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water quality in the United States. The absolute amount of water quality has failed to improve mainly because increases in agriculture run-off have offset regulatory gains4.

• Next, the scope of regulatory measures depends on the level of technology and informa-tion available for improving WUE, market conditions, and the nature of existing property rights, etc. Where these means necessary for promoting market for efficient water use are absent, regulatory measures are still important, but need to be limited to the development of basic infrastructure for implementing and monitoring various economic incentives. But a gradual shift towards incentive-based regulatory measures such as quota and tax systems and integration with market-based measures would be necessary.

The bottom line is that one key element in regulation is the level of transaction cost associated with its implementation. In most cases, analysts and regulators estimate the level of transaction cost to make the regulatory intervention more attractive to policy makers, and later it is turned to be not sustainable.

Monetary Means

Basic Concepts

Irrigation water has long been considered a public good, which is provided to the public at a nominal price. It is only in recent years that charging a fee for irrigation water with an aim of covering system operation and maintenance cost, or for recovering a portion of the initial in-vestment, has received some attention. Also, only recently management of water as an economic good emerged in international forums (Briscoe, 1996), and is being implemented in various countries. As an economic good, users can be signaled regarding the value of water through a variety of incentives, including pricing. Here one has to distinguish between pricing aimed at signaling the opportunity cost associated with the use of water (e.g., volumetric pricing based on the marginal value or opportunity cost of water), and pricing aimed at achieving financial sus-tainability of the water service (e.g., flat rate or output pricing based on the cost recovery ap-proach).

Still under-pricing or lack of full pricing of irrigation water is considered a major cause of low WUE. Farmers are usually price responsive in their use of irrigation water and an increase in price could lead to the use of less water on a given crop and adoption of more water-conserving/efficient technologies (Rosegrant and Ringler, 1998).5 Monetary means of improving WUE involve different measures ranging from area pricing (partial or full cost recovery), water-

4 The recent USEPA Report on groundwater quality (2000) indicated that although concentration of industrial pesti-cides in groundwater were found low, the concentration of some herbicides were elevated in the samples collected for streams and shallow groundwater wells. In the case of nitrate concentration, about 12 percent of domestic supply wells exceeded the water quality standard of 10mg/litre. Likewise, the report also cites more than 65 percent of the samples tested in Oklahoma city during mid-1990s exceeding 3 mg/litre and 27 percent of the samples exceeding 10 mg/litre (USEPA, 2000). The report also highlighted that in terms of health impacts of the deteriorating water qual-ity could be significant. These all indicate a mixed impacts of regulatory and recently introduced market-based measures with some improvements in quality in the recent years. 5 Effective impact of water pricing is subject to the increase in price relative to the gap between the value of water to

the user and the existing price. Therefore, if the new price to the user is still below the value of unit of water to the user, it will not induce any change in behavior.

10

related inputs taxes or subsidies, output pricing, volumetric water pricing, to the development of water market for facilitating water trading at regional and inter-sectoral level6.


Reforms in economic pricing of irrigation water and effective implementation of charging schemes, however, have been a major problem. Although water experts feel comfortable in cal-culating efficient water pricing schemes, the political economy of pricing policy reforms has rather been a complex process (Dinar, 2000; Johansson, 2000). Introduction of monetary means such as pricing and subsidy schemes alone are not without problems due to various reasons, such as:

• First, if water charge is based on the fixed or flat rate system, this may only act as an incentive to the farmers to use more water.

• Second, farmers would like to substitute water for other factors of production such as la-bor. For example, in rice farming, pounding of water in greater depth helps to allow less weed growth and would reduce labor costs (Chanceler, 1997). The effectiveness of monetary measures would also depend on other substitutes or technology available.

• Third, implementation of monetary measures such as those based on marginal cost pric-ing (input pricing) and marginal value product (output-based pricing) are very difficult to design and implement due to problems in observing and collecting sufficient information needed to estimate the optimal price based on marginal cost and benefits (asymmetric in-formation).

• Fourth, the use of monetary means such as increased water price could also have negative impact on the smallholder farmers and those practicing subsistence level farming. Usu-ally in irrigated areas, the larger producers have gained more than the small producers have and though poverty has to some extent diminished, income inequality has probably worsened (Yoduleman, 1989). Likewise, during periods of droughts or scarcity, if price increases to the level necessary, lower income groups may be negatively affected (Dinar and Subramaniam, 1998).

• Finally, lack of political will and low level of collection of user charges are the major obstacles in implementing the monetary means.

As already has been observed in many cases, there is a great deal of implementation difficulty when monetary means are considered. The design and adaptation of the scheme to the local conditions, as well as the process of its implementation are pre-requisites to its sustainable exis-tence. Next monetary means such as volumetric pricing may also require additional investments for meter installation and involve operation and maintenance as well as administrative complex-ity (Mohammad and Savenjie, 2000).

However, public perception towards the need for itroducing monetary means for motiva ting WUE is changing. In a comparison between regulatory vs. incentive-based water policy in the

6 Past experience from California and other locations in the United States has shown that a 10 percent increase in

water price would decrease agriculture water use in California by 6.5 percent and in 17 other states by 3.7 percent (Anderson and Lohof, 1997). Monetary means such as price and subsidy could also be used for irrigation equip-ment, which could be used for controlling the diffusion of irrigation methods (Anderson, 1995; Dinar and Yaron, 1990, cited in Johansson, 2000).

11

Pacific Northwest of the U.S., Schaible (2000) favors incentives over regulation. Schaible dem-onstrates that conservation- incentive water policy, when integrated within balanced policy re-form can produce upwards of 1.7 million acre foot of on-farm conserved water for the region, while also significantly increasing economic returns to farmers. In developing countries, while volumetric pricing at the farm-plot level may involve additional investments at the initial stage, it would demand less investment if introduced at the tertiary level. In order to reduce the overall transaction costs, farmers’ communities or organizations operating below this level could be as-signed for managing water on volumetric basis with transfer of property rights and adoption of revenue recycling mechanism for the installation of measuring devices.

Other means: Capacity

Basic Concepts

The capacity for increasing WUE refers to both the physical and institutional or organizational capacity compatible with the hydrological and agro-ecological characteristics of the water source and irrigation areas. The physical structures and facilities created should facilitate in handling season to season and year to year variability in water flow, for rational balance of available water among different competing uses and in maintaining ecological health. Besides, public institu-tions should also become more accountable to provide water with greater flexibility and reliabil-ity according to the changing physical conditions. The next critical factor for improving WUE is the involvement and strengthening of the capacity of water users. Studies on water users groups from different regions and countries also suggest that farmer-managed irrigation systems with user groups sharing the responsibility have shown a greater flexibility and reliability in water supplies and water distribution according to the allocated rights or quotas (Box A-3.3).

Practical Issues in Implementation

Most irrigation systems are less flexible to the changing demand patterns and both the reservoir and main canal as well as the dis tribution system operating capacity need to be strengthened. This will, however, escalate the cost of irrigation water supply, if attention is paid only towards improving the capacity of physical infrastructures. The socio-technological approach rather than either approach in isolation, would help in reducing the transaction costs and in promoting the integrated approach to improving WUE.

Ownership of Resource

Basic Concepts

Clear identification and transfer of water rights to the users is considered to be a supporting mechanism that could help promote WUE. Definition and implementation of ownership or water rights is an institutional arrangement governing economic activities including water use. These include state, private, common and non-property regimes (Bromely, 2000) and usually the type of property regimes7 is governed by the nature of water scarcity and hydro-geological character-

7 In most countries, water rights are based on one of three current systems of riparian rights: i) linking ownership to

adjacent land ownership, ii) public allocation based on priorities of use determined by the government, and iii) prior allocation as determined by the actual historical use (Sampath, 1992; Holden and Thobani, 1996; cited in Jo-hansson, 2000). Such priority systems are becoming more common as water scarcity increases and corresponds to:

12

istics of the river basin (FAO, 1996). The allocation of ownership to the water users could also reduce transaction costs (FAO, 1996), and increase farmers' willingness to invest in water-conserving technologies (Appendix 3.3).


• First, the ecological characteristics of the river basins largely determine the existence of different types of property right regimes for managing irrigation water (Wade, 1995) and property regimes thus need to be defined and developed based on the hydro-geological characteristics.

• Next, the mode of implementation for transferring ownership and strengthening WUAs also varies highly from one country to another. For example, one issue is - which ap-proach could be more successful -- "bottom-up" or "top-down"? While the National Irri-gation Administration (NIA) in the Philippines started with the 'bottom-up' approach for allocating user rights, in Columbia it was started with the 'top-down' approach (Gro-enfeldt and Sun, 1997)8.

SCOPE OF POLICY INTERVENTION

Implementation of various monetary and non-monetary measures outlined in Section 4, and the scope of policy intervention for improving WUE differs according to the level of water scarcity, river basin hydrology, the nature of market, and the institutional capacity. In the past, much fo-cus was laid on managing irrigation water at the farm level. But localized efforts alone are not sufficient for increasing WUE and need to be extended at the basin-wide level (El-Beltagy and Oweis, 1998). Policy challenges at the water-supplier level or basin-wide level are different from those at the on-farm level which demand adoption of a more integrated approach in making policy interventions. Likewise, policy intervention at various levels of hierarchy also has differ-ent implications on various faces of WUE. While policy intervention at the farm level might im-prove application or end-use efficiency, policy intervention at the regional level and inter-sectoral level might help to improve allocative and ecological efficiency (see Fig. A-2.1).

Policy Intervention at the Regional Level

Basic Concepts and Issues

The regional approach to policy intervention includes a mix of on-farm, sectoral and inter-sectoral water allocation measures depending upon the hydrological and socio-economic settings of the region or river basin. When a river basin or catchment area is more heterogeneous, in both the hydrological and socio-economic characteristics, the sectoral or inter-sectoral approach to policy intervention would be more cost-effective for promoting end-use, allocative, and overall economic efficiency of water use in the region. There are a number of objectives and economic

i) water rights, ii) sale of water rights, iii) water rights prices, and iii) transactions between willing buyers and sellers appearing to meet the test of fairness (Howe, 1996).

8 Other issues are related to the long-term performance and financial sustainability of the water user groups, which largely depend on co-evolutionary development of the organization system with the changing environmental con-ditions. In Nepal, analysis of more than 10 large-scale farmer-managed irrigation systems along the terai (plain areas) belts and upper watershed conditions indicated that those systems, which co-evolved with the changing en-vironment, are functioning well while others collapsed over time (Tiwari, 1993).

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incentive measures, which are interrelated at the river basin or regional level. Policy intervention for increasing WUE at the regional level thus becomes more relevant when:

• there are upstream and downstream hydrological links, increased interdependency and conflicts among the water users augmenting water from different sources within a river basin;

• possibility exists of increasing per unit output or economic value of irrigation water through re-allocation of water in different spatial locations in the region;

• externalities associated with water use in the region are present, which are not well cap-tured by the policy intervention at the local level, and

• the existing administrative boundaries are usually different than the hydrological bounda-ries, and institutional arrangements lack sectoral co-ordination for solving water crisis in different sectors of the economy;

Practical Applications and Scope of Policy Intervention

The regional or river basin approach to policy intervention for improving WUE has become in-creasingly popular and the transition toward making policy interventions at the regional level is taking place in many regions in different hydrological and institutional settings9 (also see Box A-4.1). However, a complex hydrological, socio-technical, economic, and political process is in-volved in the institutional design and implementation of the policy measures at the regional level. These include: i) priority to the fulfillment of basic needs, especially to those of the poor segments of the population; ii) increased need and demand of water for maintaining ecological balance; and iii) the need for greater participation of local people in all sectors of water use.

Policy Intervention at Sectoral Level


Sectoral approach to policy intervention provide a wider basis for improving WUE as greater at-tention is paid on policy issues such as pricing and decentralization that extend beyond the con-text of individual projects (WB, 1993). The sectoral approach to WUE involves policy interven-tion directly to productive sectors (agriculture and industry), productive infrastructure sectors (ir-rigation and power) and social infrastructure (health and water supply) (Ghooprasert, 1990). The water sector in itself is diverse and large, and policy intervention at the sectoral level could help specially to improve end-use efficiency and should aim at improving WUE without detriment to the social, and economic structure of the beneficiaries and damage to the environment (Tibor, 2000). Efforts toward making policy reforms in the water sector need a shift from development

9 For example, the Tenesse Valley Authority (TVA) established in 1993 in the United States facilitates and regulates

water allocation, pollution, and flood control, and also engages in comprehensive regulatory development. Vari-ous river basin committees in France provide some very good examples of policy interventions at the regional or basinwide level (Naagraj, 1999). The French model is based on a more decentralized institutional structure and state intervention in water affairs is basically happens to facilitate on a co-ordination role of the decentralized ser-vices of the State in implementing the measures (Cheret, 1994). In Poland, Regional Water Committees, which are composed of the representatives, local self-governing authorities, and water users, are charged with water policy making in the basin (Kindler, 1994). In some other countries including Australia, Brazil, India, and Mexico, sev-eral river basin organizations exist, which are mostly based on hydro-geological boundaries and provide institu-tional potential for pursuing an integrated approach and resolving regional and sectoral water allocation conflicts (Saleth and Dinar, 1999).

14

toward allocation, greater emphasis on decentralization, and the adoption of integrated approach (Saleth and Dinar, 1999).


Sectoral policy intervention in the past has largely been in the form of preparation of water sector (or irrigation sector) review in the developing countries with external assistance10. The scope of policy intervention at the sectoral level exists in creating both enabling conditions and sharpen-ing of enabling condition through creation of incentives for more rational use of water (Win-penny, 1997), for example:

• re-orientation of water development strategies, sectoral/regional water allocation mecha-nisms, legislation and regulations for facilitating the adoption of demand management strategies;

• decentralization of water services and strengthening of the institutional linkages between government agencies and community organizations; development of institutional mecha-nisms that reduce transaction cost for transferring property rights to the users, encourage participation of beneficiaries and affected parties in water management; and

• development of incentive sys tem for the protection of water sources at water supplier-level, e.g., assignment of water rights to the upper watershed area inhabitants, and devel-opment of mechanism for sharing benefits of water use from the water source. This will also help address the poverty issue as majority of the rural population living in upper wa-tershed areas in the developing countries is within the low-income brackets.

Policy Intervention at the Inter-sectoral Level


Efficient allocation of water requires to strike a balance among the host of competing users and must supply an acceptable means of handling year to year variability in surface water flow (Ti-etenberg, 1988). The rational for policy intervention at the inter-sectoral level is that taking water away from one sector (e.g., agriculture, which consumes large portions of available water but contributes a small percentage of GDP), can result in significant savings of water without a ma-jor loss in the overall income (Turton, 1999). This surplus water can then be re-allocated among the economic sectors in a way that generates equal marginal benefits of water use across the sec-tors. Policy intervention at the inter-sectoral level would thus help to increase allocative and eco-nomic efficiency of water use.

10 In countries such as Mexico and Chile, the main thrust of water policy review has been toward promo ting WUE

and improving water quality through privatization and provision of economic incentive measures (FAO, 1995). In most of the developing countries, however, water sector policy review has been limited to the projection of sec-toral demand and supply of water and suggestions for institutional arrangements. Water sector reforms carried out in the past also differ among the countries, but some commonalties exist such as shift from water resource devel-opment to water allocation, emphasis on decentralization and participation, integrated approach to water manage-ment, and premium for economic viability and physical sustainability (Saleth and Dinar, 1999). Most of these country strategy reports have also identified absence of incentive mechanisms to conserve water (FAO, 1995), and there exists wide scope for making policy intervention even at the sectoral level for water sector reform toward fa-cilitating demand management strategies.

15


Some level of inter-sectoral water markets exists in countries like Australia, Spain, Chile, and the United States11. In most of the developing countries, including China, the inter-sectoral water al-location mechanism still remains largely undeveloped (Saleth and Dinar, 1999) and there exists a wide scope for making policy intervention at this level. However, a change in water policy that demands application of the marginal benefit concept as a measure of water allocation across sec-tors may not always be compatible with the national priorities such as food sufficiency, rural employment generation, and poverty alleviation12.

• First, the food security concerns and livelihood of the poor may be negatively affected13. There is need for the establishment of secure water rights, recycling of gains in rural de-velopment programs, and provision of an adequate compensation mechanism for the af-fected third parties (Rosegrant and Ringler, 1998).

• Second, the inter-sectoral allocation and water transfer also will change the established patterns of use with impact on the existing rights and users' conservation behavior. Pro-moting inter-sectoral allocation with water transfer mechanisms affects the use patterns and could create economic externalities in terms of lost jobs in agriculture when water transfer takes place in large amounts from agriculture to other uses (Green and Hamilton, 2000).

• Finally, the hydro-geological boundary, nature of conflicts in sectoral water allocation, and the level of decentralization could also largely influence the scope of policy interven-tion.

Policy Intervention at the Economywide Level


Water plays a crucial role in the economic development of nations. During industrialization, wa-ter-related development or use generally increases and decreases at the later stage of develop-ment as a result of the technological advance (Falkenmark and Lindh, 1993). The key role that

11 In these countries, high-level inter-sectoral and inter-ministerial mechanisms have been formed to enable an inte-

grated water sector perspective and to resolve the allocation conflicts (Saleth and Dinar, 1999). For example, in Chile, active water markets have been developed between agriculture and other sectors in several regions. These arrangements have allowed the sale and lease of water to companies and industrial users (Hearne and Easter, 1995). The California waters bank in the United States transferred water within the irrigation sector and to urban uses in 1991 during the drought period. Likewise, Idaho’s water banks have facilitated water transfers within the irrigated areas and to in-stream flow for salmon restoration (Howitt, 1994, Loomis, 1992; cited in Green and Hamilton, 2000).

12 For example, in rural Bangladesh, competition for scarce water resources during the dry season has favored a transfer of water from the domestic to the irrigation sector (Sadeque, 1998; cited in Rosegrant and Ringler, 1998). The reason as cited in the paper was mainly the disproportionate allocation of water among the rich and poor users who use deep and shallow tube wells to meet their demands. Further, if no supportive measures are adopted, real-location of water from agriculture to industrial and commercial uses can also have substantial negative effects on rural communities (Rosegrant and Ringler, 1998).

13 Rosegrant and Ringler (1998) point out that if water transfers from agriculture to other sectors takes place without mitigating policy impacts, it would have some impact on the food production and the prices of staple cereals in global food markets could increase sharply. This would further result in broadly negative impacts on low-income developing countries and the poor consumers in these countries.

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water plays in the national economy and that the economywide policy affect WUE have been in-creasingly recognized (Frederick, 1996; Stringer, 1997). This growing recognition of the impor-tance of water in a nation's economic development has forced governments and communities to rethink the role water plays in the economy, environment, and society (Stringer, 1997). Econo-mywide reforms and high economic growth are also supportive to the water pricing reforms and hence help in increasing WUE14. Fiscal policies such as the removal of subsidies on irrigation equipment (tractors and pumps), used by the large landowners can improve equity in irrigation areas (Yoduleman, 1989).


Many developing countries are undergoing profound changes in economywide policies at differ-ent levels and involve a number of policy considerations that could have significant positive im-pacts on the institutionalization of economic incentive measures15. The nature of policy interven-tion at the economy wide level for improving WUE, however, largely depends on how econo-mywide policies impact water use and how water scarcity and use affect the economic growth of nations (see Box A-4.2). The scope of integration of policy measures for improving WUE at the economywide level could thus be two-fold: i) managing policy reforms and ii) adjustments in the economywide policy reforms, which directly or indirectly affect agriculture water use. In terms of managing reforms, policy intervention at the economywide level could include means such as:

• suspension of policies that subsidize the construction of commercially viable large-scale irrigation projects;

• introducing institutional measures for the promotion of inter-sectoral competition for scarce water without affecting the food security concerns;

• periodic adjustments in inter-sectoral allocations that may be necessary in accordance with the stages of economic development and sectoral growth targets set out at each stages of development.

Other economywide adjustment policies for promoting efficient use of irrigation water could be related to the policy reforms in the agriculture sector. These may include reduction of input sub-sidies which may affect crop choice and hence water use, securing land tenure rights and provi-sion of credit facilities to small farmers that may also encourage farmers to make investments in sustainable agriculture practices including that on efficient water application technologies.

As regards the increasing concerns over water transfers across the national boundaries and eco-logical sustainability, trade measures under the GATT provide new areas for policy research and considerations at the economywide level. For example, the potential for large-scale water trans-

14 Dinar and Subramaniam (1998) in a study of water pricing reforms of 22 developed and developing countries in-

dicated that high income countries like Australia and New Zealand are taking more active initiatives towards wa-ter pricing policy reforms than middle and low income countries have. Further, budgetary pressure rather than budget deficits has helped to strengthen water charge systems, for exa mple in countries like Australia, Spain, and the United States. Countries like India, Pakistan, and Tanzania have often not responded to the budget deficit problems with reforms in water pricing policy.

15 For example, in Argentina, policy reforms are aimed at improving the quality of service, management efficiency, cost reduction, and expansion of the regionalization and decentralization process (Llop, 1996). These policy measures, if combined with the integrated water management objectives, could help improve water quality, reduc-tion in transaction cost, and help in establishing regional or river basin level organizations with greater user groups' involvement.

17

fer between British Columbia and USA, and Turkey and the Middle Eastern countries has in-creased the recognition of water as a trading commodity. Issues such as to what extent water transfer should take place and whether restriction on water trade could be possible under the GATT rule for ecological reasons present a new set of cha llenges (de Haan, 1997).

ROLE OF ECONOMIC INCENTIVES IN MOTIVATING IMPROVED WUE

General Concepts and Basic Issues

The increasing demand for water, growing scarcity and rising cost of augmentation have led to the realization that water has to be allocated and used more efficiently (e.g., Grimble, 1999). The relation between different economic incentive mechanisms and efficiency measures can be explained with the help of the concepts of marginal benefit (demand), marginal cost (supply), and marginal damage cost (see Text A-5.1 and Fig. A-5.1 for definition and graphical illustra-tions). In the past, economic measures such as water charge and taxes have mainly been intro-duced with the aim of generating revenue to partially cover the cost of supplies. The use of in-centive-based measures for improving efficiency in resource use is very rare in practice (OECD, 1999). One of the main reasons is said to be the fear of loosing competitive position in the world agriculture market due to integration of these measures. In this context, there is need for conceptu-alizing the cause and effect linkages between economic incentive measures and resource use effi-ciency, producers' cost and other economic variables (see Appendix Text A-5.2 and Fig. A-5.2 for graphical illustrations). The rest of this section provides a brief description on the role of economic incentive measures in motivating improved WUE at various levels of policy intervention.

Prices


“Water price” denotes any charge or levy that farmers have to pay in order to obtain access to water in their fields (OECD, 1998) and is based on the users' pay principle (UPP) that those who benefit from the use of scarce resource should pay (Dommen, 1993). The adoption of the UPP provides a basis for pricing and allocating scarce water among different users and sectors, which could help improve WUE and reduce conflicts in sharing scarce water. Theoretically, maximum economic efficiency will be attained when the price is set at the level where marginal costs and benefits are equal. However, in practice, there are several issues involved in the pricing of irri-gation water for achieving different faces of WUE (see Box A-5.1). Likewise, the reasons for requiring WUE and related water pricing could also be different. These include pricing irriga-tion water without transfer of water rights, which could promote technical efficiency; with trans-fer of water rights that could promote allocative efficiency; and with incorporation of environ-mental costs which again could promote ecological efficiency or overall WUE. Both the pricing of water and farmers, government and societal loss could vary under different water charge schemes with and without transfer of property rights (see Table A-5.2 for numerical illustration). In addition, the productivity of water is not constant over the growing season and consequently the economic value of water also highly varies.

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Means of Implementation

Pricing water as an input

The accepted basis for pricing irrigation water is to consider 'water' as one 'input' among others in the agriculture production system and charge for water based on the quantity used. The effec-tiveness of direct water charges on volumetric basis in changing the farmers' behavior will de-pend mainly on the price elasticity of water. Some recent estimates of price elasticity for irriga-tion water in a few developed economies such as Australia, and others in North America, and Western Europe indicate that the value for direct water abstractions are in the range of 0.45-0.7, 0.5, and 0.3 respectively - a wide demand elasticity range. These values indicate that water us-ers' behavior is likely to change with the change in price at a higher level (RPA, 1999). For the improvements in WUE, charges need to be implemented both on the abstraction and authoriza-tion to use, and need to be combined with mechanisms that provide incentive to release surplus water. Appendix (Box A-5.2) provides some examples of water pricing and efficiency gains in different countries.

One reservation, though, is that the impact of increased per unit price on the demand for water by irrigators depends also on the actual difference between the value of the water to the user and the its cost. If this difference is bigger than the political ability of the price regulator to increase, than any increase will likely result in no change in behavior on the part of the user (Moore, 1999).

Water Pricing Based on the Water Productivity or Outputs

In some countries, irrigation water is also charged on the basis of output per area, i.e., irrigators pay a certain water fee for each unit of output they produce. The basic concept is that farmers' should pay the charge according to the crop productivity or value of output or the marginal value product (MVP) of water they derive per unit of water used. In other words, water pricing in this case is based on the marginal benefit rather than the marginal cost. The marginal physical prod-uct (MPP) of water is estimated using the crop production function approach and by holding all other inputs, except water use, constant. The MPP is thus independent of the economics of crop production and as it is dependent only on the output price, it represents the value of on-site irri-gation water in terms of output (Gibbons, 1986). In reality, MVP could be less than the marginal cost or the scarcity rent of irrigation water (Tiwari, 1998). Though water pricing based on out-puts has several advantages (Box A-5.3) and the means adopted in some countries16 somewhat reflects the charging system according to the amount of water used as in the case of input pric-ing, water charge based on the MVP is very rare. Apart from the difficulty in measuring and fix-ing the water price based on the MPP or MVP, the next problem with output-based pricing is that, while the real cost of irrigation doubled in the past, the cereal prices fell sharply17.

16 In practice, as in the case of input pricing, output pricing in the past has not been based in the true measure of the

MPP or MVP. The output pricing system practiced in many developing countries such as in Pakistan, Philippines, Mexico, and India is based on the type of crops grown, which somewhat reflects the charging system according to the amount of water used. For example, in Pakistan, the per acre water charges were Rs 21.6/acre for wheat, Rs 32/acre for rice, Rs 33.6/acre for cotton and Rs 61.6/acre for sugar cane (28.11 Rupee = $US1 in 1993) (cited in Johansson, 2000).

17 For example in India and Indonesia, since the early 1970s, and in other countries such as Thailand and Philip-pines, the real cost of irrigation increased by 50 percent while the world cereal prices fell sharply, by almost 40 percent over the same period (FAO, 1994, Yoduleman, 1989). In such a situation, not even the double cropping of the higher valued crops can make irrigation system economical (FAO, 1994). Another concern is that the govern-

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Subsidies


Subsidy on irrigation water is considered as the difference between what farmers actually pay per unit of irrigation water and the marginal cost of supply or full cost price of water. Both in the developed and developing countries, irrigation water has been highly subsidized in the past. As farmers receive irrigation water at relatively lower price, it provides no economic incentives to them for using water more efficiently. The inefficient use of irrigation water has further resulted in waterlogging and salinity, and deterioration of water quality, and the financial cost of subsidy together with the cost of negative environmental impacts are estimated in the range of millions of dollars in different regions and countries18. Elimination of existing subsidy in the irrigation sec-tor and reinvestment of the resulting fiscal savings in efficient water use technologies could thus improve WUE and result in large monetary benefits. Removal of the existing subsidy for elimi-nating the existing inefficiency, and making a shift from ‘negative’ to ‘positive’ subsidies, for improving efficiency in water use however, involve several issues such as:

• first, the investment subsidy is considered as the most politically acceptable means for pleasing the farmers in the rural areas, though major beneficiaries of such subsidy schemes such as for irrigation water have been the agribusiness people in the past rather than the small farmers (Chadd, 1995);

• second, subsidies aimed at providing economic incentives to farmers, if not designed well and not specifically targeted to the specific group, or technology and practices that pro-mote WUE, then it may result in misallocation of resources and also, lower efficiency in water use;

• third, subsidy need to be implemented only for the transitional period required for making a shift towards the adoption of water saving technologies or practices. Otherwise, it could also result in over-dependency of farmers on such grants and credits, and would be diffi-cult to modify the farmers’ behavior; and

• finally, using subsidy as an economic incentive measure should thus be carefully imple-mented with evaluation of the impacts of existing subsidy and potential impacts of elimi-nation of such subsidy on the poor households and rural employment opportunities.

Some basic issues involved in the design of subsidy are further discussed in Appendix (Box A-5.4).

ment policy of imposing taxes on agriculture products or a measure which keeps the agriculture prices relatively low would result in a low MVP. This would further encourage excessive use of water and other agriculture inputs (Easter, 1992).

18 For example, in the United States, government collection of revenue from water projects constituted only 15 per-cent of the construction cost (Wahl, 1994, cited in Anderson et al., 1997). In some developing countries, the an-nual irrigation subsidies range from $0.6 billion for example in Pakistan, to $1.2 billion in India and $5.0 billion in Egypt (Rosegrant, 1997).

20


The adoption of subsidy measures for promoting efficient resource use is often practiced for promoting environmentally friendly technologies19, but it is also used to promote water savings, from which society as a whole may benefit 20. Different types of subsidies such as grants or pay-ments to farmers (for example, see Box A-5.5), budgetary subsidies (e.g., tax credits), provision of extension services, preference loans, debt relief, etc. could be implemented depending upon their effectiveness and suitability to a particular country such as:

• Subsidies that constitute payment for part of the investment cost (e.g., in the form of tax credits or grants) on water conservation technologies to be paid to the farmers on the basis of per unit water saved or designated types of water saving technologies;

• Conservation subsidies for crop diversification to be paid on the basis of water saved per unit crop area, or loss in productivity or incremental cost of production (e.g., for making a shift from rice to non-rice crops which consume less water, adoption of sus-tainable agr iculture practices such as conservation tillage, integrated plant nutrition management and soil moisture conservation practices);

• Research grants for undertaking the research on efficient water application technolo-gies, and management practices;

• Conservation subsidies to the households living in the upper watershed areas, who are usually marginalized farmers and are instrumental to the protection of watershed re-sources and in maintaining water quality upstream, etc.

Taxes


Tax incentives are designed to modify behavior by encouraging particular groups or activities, and could be implemented in the form of preferential tax treatment to certain producers through tax credits, exemption or deductions, or through tax benefits provided to investors (MSSC, 1992). Irrigated agriculture does not only consume a large share of the available water, but also generates externalities 21 during the agricultural production process. For example, the excess pumping of ground water directly lowers the water table and also increases trans-evaporation of water, which results in negative regional water balance. The excess withdrawal of water also re-sults in degradation of ecosystems because the minimum water requirement of the ecosystem is not met due to lowering of the water table and reduction of regional water balance. A tax incentive equal to the marginal environmental damage cost could be designed and implemented so that the

19 In the OECD countries, the subsidy measures have helped to promote employment opportunities in environmental

industries, ranging from 3 percent in Canada and Japan to 10 percent in the United States. From an environmental perspective, the more specific the subsidy is, the more it should be possible to target specific environmental prob-lems (OECD, 1996). A shift in subsidy from irrigation water to efficiency improving technology and cultivation practices is yet to be materialized both in the developed and developing countries.

20 If the reduction in social cost is greater than the value of the subsidy, it is usually justified. 21 Overuse of irrigation water also increases water logging and salinity and degradation of water quality downstream

thereby increasing replacement and water treatment costs. For example, in the Murray River basin in Australia, while the production loss due to salinity is estimated to A$ 67 million per year, the cost of current level of salinity is estimated to A$37 million per year (CSD, 1997).

21

water price also addresses these ecological concerns. Indirectly, environmental taxes also can be imposed on the water-related inputs such as energy inputs and chemical fertilizers, which also partly influence the level of water use. Usually energy used in water abstraction is highly subsi-dized and encourages farmers to use more water at a relatively lower cost of extraction.

The design and implementation of environmental taxes for improving resource use efficiency, however, is not so simple. There are several issues related to the design of tax such as the selection of a tax base, incidence of tax burdens, and stability of revenue generation when a shift of tax from ”good” tax to ''bad” is made for reducing the overall burden. The design of the optimal environ-mental tax is based on the Pigouvian concepts of equating marginal benefits with marginal cost, which requires information on both of these aspects. This is, however, almost a Herculean task for developing countries. Yet, the experience of some developed countries on water abstraction charge and taxes on agriculture inputs could help in conceptualising the benefits of such measures for im-proving WUE (for example, see Box A-5.6) and gradual adoption of environmental tax measures.


Taxes on Water Abstraction

The water abstraction charge consists of two elements: i) an application charge to be paid when applying for a license, and ii) an annual charge. The annual charge is based on the licensed vol-ume taking into account: i) the source, with highest charge on ground water abstraction, ii) sea-sonal factor, with higher charges levied in the summer when resources are under greatest stress, and iii) loss factor, i.e., how much of the abstracted water is returned. Also, different unit charges are applied in different regions to take into account the spatial scarcity of water (Krinner et al., 1999). Generally, a license or quota system is used for allowing the abstraction of ground water, and the charge is estimated by multiplying the annual licensed volume by source factor, sea-son factor, loss factor, and the standard unit charge (Smith, 1995). Various other factors influenc-ing abstraction charges are briefly discussed further in Appendix (Box A-5.7).

Taxes on Environmental Damage

In practice, the problem of agriculture water pollution, both in the Western European countries and the United States, have mainly been addressed through a series of directives and provision of sub-sidies for controlling pollution. The tax-based incentives have not been applied much to agricul-ture. One reason might be the non-point source nature of agricultural pollution and monitoring dif-ficulties. Another reason as Scheierling (1995) pointed out, could probably be concerns about the adverse effects on the farming sector. The only example available on the adoption of water charge considering both the users' pay and polluters pay principles is that of France (Box A-5.8). While several economic incentives have been suggested for controlling non-point agriculture pollution (Malik, Larson and Ribaudo, 1994), it would be more practical to tax polluting inputs directly for the excessive use of such inputs mainly responsible for water pollution downstream. In the case of ecological damages due to excess water diversion or abstraction, the water abstraction charge should also reflect these costs.

Taxes on Related Inputs

Other major agriculture inputs, which may influence WUE in irrigated agriculture, are energy and chemical fertilizer use. It is estimated that the total amount of energy needed to operate irri-gation equipment is about five times that required for its manufacture, and accounts for about 23 percent of energy use for all other agricultural field operations. The energy requirements may in-

22

crease with the inefficient water application practices22. Taxes on energy and chemical inputs (see Box A-5.9), tradable quotas, and subsidies for land retirement or water conserving agricul-ture practices, could be some of the direct and indirect means for reducing water-related inputs and water use (Malik, Larson and Ribaudo, 1994)23.

Quotas


The quota system is used to define the limit on water use or how much to use, when, by whom, and for what purpose water can be augmented and used (Morris et al. 1997). When users' behavior is not very responsive to price changes, because of rigid price elasticity, or when uncertainty is involved in the computation of marginal cost and benefit, quota regulation is suggested as one of the measures for controlling water use (Mohamed and Sevenije, 2000). The difference between quota and pricing sys-tem is that in the former case, the marginal social costs associated with each unit of abstraction are as-sumed minimized through the setting of some standards. Likewise, the basic difference between a quota and right allocation is that the former may have various conditionalities, including a pre-determined price, and be subject to modifications, based on external conditions and number if users, or participants.

The effective implementation of quota system among others, requires specification of quota entitle-ments, and the total amount of water allocated under quota system that corresponds to the sustainable level of water augmentation (Tietenberg, 1988). The quota systems are often rigid and not transfe rable (the “use-it-or-loose- it” principle) and difficult to implement, if farmers are enjoying priority rights of unregulated water use. Also except under certain conditions, such as droughts, the effectiveness of quota systems in improving WUE is rather limited, as farmers would not have economic incentive to use less water or transfer or sale their share of water to other users. Some additional issues involved in the implementation of fixed quota system are outlined in Appendix (Box A-5.10).

Means of implementation

Quotas can be fixed both in terms of output (e.g., providing license for freshwater augmentation and input (directly for water use). The quota system has been widely practiced both at the country and re-gional level (Box A-5.11), and are implemented in terms of:

• fixed quota system for groundwater pumping with specification of annual rate of extraction in proportion to the to the land area for each water user;

• allocation of water share in fixed amounts to different canals/water users sharing water from the same source or river;

22 The amount of energy used in irrigation is expected to rise further by about 50 to 75 percent by 2020 compared to

the base year 1985 (Stout et al., 1979; Barnes et al., 1973; Sloggett et al., 1979; Smerdon and Hiler, 1980; cited in Alfaro and Martin, 1994). In Morocco, agriculture sector enjoys a "green tariff” for electricity, which is about 20 percent lower compared to the other sectors (Kadi, 1998). Such bonus energy tariffs to the agriculture sector are common in most of the developing countries.

23 Adjustment in the energy price, or taxes on energy inputs used in irrigation water extraction and applications, could thus help change inefficient water use practices. Most developing countries subsidize energy use in agricul-ture with the aim of increasing agriculture production. One possible government policy intervention could be a gradual shift of such subsidies by equalizing the energy price with other sectors and re-investing the gains for sub-sidizing the transfer and adoption of energy efficient technologies in agriculture.

23

• allocation of fixed quota to Water Users Association (WUAs), for example, in Maharstra In-dia, the WUA receives 0.77, 0.86 and 0.62 million cubic meter (mcm) of water during winter, dry and summer seasons respectively and the users’ association is also allowed to draw unused quota of water from the previous season (Naik and Karlo, 1998).

Ownership/Rights


“Ownership” or ”water rights” refers to the right acquired by the user under government regula-tion or water law for the abstraction, diversion, and use of water. Water right is acquired through quota or permits, if the right belongs to the government (state property regimes), through enti-tlements or sharing resource mobilization if under the community (common property regimes) and traditional right regimes24. Lessons from successful water markets in Mexico also indicate that water rights need to be clearly defined and allocated (Klozen, 1998). There is also an inter-relation between the property regimes and pricing regimes, and water management needs to be understood as a part of the structure of property right regimes (Bromley, 2000). Property-right systems also help in achieving ecological efficiency as they define the ecological limits, and then leave the market to work out what prices and charges are necessary to keep use within those lim-its across space and through time (Young, 1997). Usually, property rights are assigned on the basis of traditional rights, resource mobilization patterns and land entitlements, and through the quota system to new users who will have to purchase quotas to acquire the rights over water from the right holders. In allocating the water rights in the changing environment, attention should also be given to the changing ecological demand and the need of poor population seg-ments.


Water rights can be allocated in terms of a share of stream flow, aquifer, or reservoir and in terms of quota or water purchase rights. When rights are defined by quantity, typically two methods are used to address water scarcity - on a priority basis (e.g., senior water-rights holders as in California, USA) and on a proportional division based on expected shortages (Easter, Becker, and Tsur, 1997, cited in Johansson, 2000). Water rights also specify how water will be divided between sectors (industrial, domestic, and agricultural consumption) and also within sec-tors, as might be the case between individual farmers (Holden and Thobani, 1996, cited in Jo-hansson, 2000). These different kinds of private or community regimes take place at various levels of hierarchy and in some cases property rights are distinguished according to the water-related infrastructures and by considering water as a production input. Likewise, granting rights to users' groups for the regulation, collection, and use of water fees is another means of imple-menting the water rights.

24 Allocation of water rights under the state property regimes could be made according to the purpose of use. When

the water right could be sold as in the case of other commodities, it takes the form of water trading and such rights are allocated for promoting the market and allocative efficiency of water use. Ownership in the form of defined property regimes also provides an incentive to the farmer to invest in greater productivity, while freedom to trade the rights provides greater flexibility to reallocate entitlements according to the changing social demands and con-ditions (Bauer, 1997).

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Rights on Water Infrastructures

Under the state property regimes, the allocation of water right simply refers to the right to use. The state holds the operation and management authority over the water supply systems, such as reservoirs and main canal systems. The rights over physical infrastructures such as those below the main canal or secondary canal is handed over to the “water users' groups” for operation and maintenance, and users hold right on these infrastructures. The entitlement for water use under such property right structure is usually limited to farmers within the defined boundaries such as within tertiary or secondary canals, and thus could only partially help to increase distributive ef-ficiency. These types of arrangements for rights over physical infrastructures exist in large-scale irrigation projects in the developing countries. The advantage with such a system is that opera-tion and management respons ibility is shared between the government and users and technical efficiency could be improved, if there is better co-ordination in operation and management.

Rights on Water as a Production Input or Commodity

Increasingly, water rights are acquired through quotas or permit systems if they are under the state property regimes, or as water allocation units, under the common property regimes. Such water rights arrangements provide ownership of the water to users or license holders and encour-age them to invest in conservation activities, as they would benefit from such investments in the long run. In such a case, entry and exit from the system could be made possible only by trading a part of the shares entitled to the initial users. Similar impacts are expected in the case of land ownership (Feder et al., 1988), which motivates owners to invest in long-term practices for im-proving WUE.

Rights to Collect and Use of Revenue to the User Groups

Provisions of water rights are not limited to handing over responsibility for O&M of irrigation infrastructures and for water use as one of the production inputs. Water is usually considered as a part of the national wealth and the revenue generated from water use goes to the public fund. In such a case, the stability of the water right itself is questioned, users need to be provided rights to create their own financial autonomous association and participate in decisions and investments (Kloezen, 1998). Users could be granted rights over regulation and collection of water charge, and recycle part of the revenue collected for investing in efficient water application technologies.

Allocating Water Rights with Ecological Considerations

The property right structure also needs to be ecologically friendly, which recognizes the ecologi-cal limits while sharing the entitlements. Actually, property-right systems tend to be ecologi-cally more dependable than pricing systems (Young, 1997). Young (1997) also favors adoption of a dual rights system under which the entitlement is formally separated to receive water alloca-tions on a regular basis from volumes that have been assigned to the users. The regular alloca-tions would be made as per share, and adjustments in water entitlements would be made accord-ing to water availability in the catchment and the credited share is met when it becomes avail-able.

REVIEW OF ACTIVE BANK IRRIGATION PORTFOLIO

The review of the active Irrigation and Drainage (I&D) projects of the World Bank portfolio was performed. In addition to being able to identify trends in design and implementation of eco-nomic incentives, the review provides an opportunity to identify non-pedestrian economic incen-

25

tives used in various projects and their implementation. As such this section supplements the ex-amples taken from other sources of I&D projects around the world.

Methodology

Based on the framework described earlier in the report, a list of several economic incentives have been prepared. The list comprises of the following incentives: (1) Water pricing, (2) Subsidiz-ing/taxing Irrigation equipment and other new technologies; (3) Subsidizing/taxing other agricul-tural water-related inputs; (4) Transferring production assets to users; (5) Awarding water rights to users; (6) Establishing water user associations; (7) Transferring management of water opera-tion to users or to private sector; (8) Building capacity of either users or water suppliers; (9) Im-posing water or output quotas; (10) Establishing water markets.

A close reading of each individual project report (either Staff Appraisal Report or Project Ap-praisal Document) was conducted between September 1, 2000 and December 28, 2000 and a summary, describing each relevant incentive that was included in the project design was pro-duced. Non-pedestrian incentives were detected as well and will be followed by a close inter-view of the task manager of the project, in which they were designed to be implemented.

In addition to a verbal ana lysis of the results of the review, a simple descriptive statistics is pre-sented, followed by some time trends of important variables. In the statistical analysis, each economic incentive that was observed, was given a value of one, allowing numerical calcula-tions. Although this codification eliminates some aspects of interest in the details associated with the particular incentive, the ‘hidden’ information will be posted and discussed in the qualitative analysis.

Data and characteristics of the portfolio

The active I&D portfolio (as of September 2000) includes 67 projects (An additional project that is not defined as I&D was included as well, bringing the total number of projects to 68). Table 6.1 presents the distribution of the projects by year of approval.

Table 6.1: Distribution of WB I&D portfolio by year of project approval.

Year No. of Projects Approved

1991 1

1992 1

1993 6

1994 11

1995 6

1996 7

1997 9

1998 9

1999 10

2000 7

Total 68

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One has to remember that the active portfolio still includes projects that were approved as early as 1991. Except for one project per year that remains active in the portfolio for 1991 and 1992, the portfolio includes an average of about 7-9 projects per year for the period 1993-2000.

General results

Descriptive statistics

The 67 projects included in the analysis (documents for one project were not sufficient) vary in the number of incentives they include. The values range between 5 incentives per project to no incentives at all (most of the project in this category are sector investment loans, or emergency projects). Table 6.2 presents the distribution of the incentives per project.

Table 6.2: Distribution of incentives per project

Judging from the number of incentives per project, one can notice that except for the projects with no incentives, and the incentive- intensive projects, the distribution of 1-3 incentives per project is roughly equal.

One would expect to find an increasing number of incentives per project as the 1993 water policy became more operational. Table 6.3 presents the distribution of incentives per project over time.

Table 6.3: Distribution of economic incentives per project over time.

Year Average number of incentives per project 1991 4.00 1992 1.00 1993 1.83 1994 1.73 1995 2.20 1996 1.71 1997 3.11 1998 1.67 1999 1.90 2000 1.57

Number of incentives per project Number of projects

0 9

1 17

2 15

3 19

4 6

5 1

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However, from the data in Table 6.3, it is evident that there is no trend of use of incentives per project over time. It can be therefore concluded that a decision to include economic incentives in the design of a specific project is based on the conditions prevailing in the sector and the country at the time of design.

Focusing now on the specific economic incentives, Figure 6.1 presents the number of projects implementing the various incentives. It can be seen that water pricing—included in 52 projects (in varying degrees of types and effectiveness), is the most used incentive. However, one has to be cautious in dealing with all types of water charging mechanisms that have been included in the reviewed projects. Most of them are aiming at cost recovery and cannot be considered incen-tives to the users. A more elaborated discussion will follow in the next section.

The second most used set of incentives is the user participation (34 projects), which encompasses various types of involvement of users in the management of the irrigation project. Although many types of user participation were included under this incentive, all act in the same direc-tion—motivating users—and therefore, they can be grouped together. Additional discussion will also follow.

Figure 6.1: Distribution of the various incentives

Capacity building, establishment of land and water rights, and transfer of assets to users (in-cluded in 17, 9, and 9 projects, respectively), are the next in use. Capacity building is used for both users and water managers, establishment of water and land rights—an incentive that is sup-posed to increase security and thus a more careful use of the resource—were treated separately from another institution—water markets. Not in all cases where water rights were established, they were followed by the setting of tradable mechanisms. The transfer of assets to users, in most cases dealt with tertiary canals and their operation only. A couple of cases gave users more say in equipment operation and investment.

0.0

10.0

20.0

30.0

40.0

50.0

60.0

1

Pricing

New TechnologiesOther InputsTransfer of AssetsWater/Land Rights

Users ParticipationCapacity BuildingQuotasMarkets for water

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Fewer projects (7, 3, 0, and 2) used incentives that affect new technologies (mainly irrigation technologies), water-related inputs (such as electricity, seeds, and fertilizers), water quotas, and establishment of water markets.

Detailed analysis of the various incentives

In this section we will introduce the various types of incentives included under each category, and also will highlight some of the more interesting and likely-promising cases.

Water Prices/fees

The distribution of the various pricing/cost recovery mechanisms is presented in Table 6.4. As can be seen, the majority of the projects (63%) have non- incentive water pricing mechanisms, and 17% do not identify the pricing mechanism. Only 20% of the projects reviewed include volumetric measures of water that allow the design of incentive-based pricing. While the major-ity of the projects include cost recovery pricing, 25% also allow for a gradual increase to reach full cost recovery at the end of the project.

Table 6. 4: Distribution of pricing incentives

Type of water pricing Number of Projects, (%)

Volumetric, targeting O&M and investment 6 (12)

Volumetric, targeting O&M 4 (8)

Annual fixed fee for O&M and/or Capital 13 (25)

Fee, gradually increasing to cover O&M and/or Capital 11 (21)

Land based fixed fee, targeting O&M 9 (17)

Mechanism not determined 9 (17)

Total 52 (100)

We identified in the review two projects with interesting incentive features of cost recovery that if appropriately designed, can motivate users. By involving users in the project from the first stage, and by acknowledging their responsibility, the users become more responsible and effi-cient:

The first case is the “No Payment No Project” Principle that was implemented in the NISP Pro-ject of Nepal, and is part of the Irrigation Policy of Nepal. In accordance with the Irrigation Pol-icy (IP) principles, private and public systems would be considered eligible for funding under (Nepal Irrigation Sector Project) NISP upon written applications of beneficiary farmers backed up by their financial contribution to investment costs. The no Payment No Project princ iple would be applied.

The Up-front Cost Sharing in NDP of Pakistan is the second example. The National Drainage Program project in Pakistan will progressively ensure that all O&M costs are covered. (Provin-cial Irrigation and Drainage Agencies) PIDAs and (Area Water Boards) AWBs would become financially self-sustained for O&M cost within 10 years and (Farmer Organizations) FOs within 7 years. Up-front cost sharing for capital investment (compared with back-end cost recovery in

29

many other projects) will prevail. This cost sharing agreement will be stipulated in the Participa-tion Agreements between the Provinces and PIDAs, AWBs and FOs.

User Participation

Thirty four projects implemented incentives via involvement of users and the private sector. The majority (79%) assign the O&M responsibility to the Water User Association (WUA), as a basic level of involvement. This includes, fee collection and payment, allocation of the water among the members, operating the system, and periodical maintenance. Fewer projects (18%) include also full involvement of users in planning, investment decisions, and replacement of equipment. One project in the portfolio doesn’t specify the role of the WUA.

We were able to identify one project with interesting participatory features. In the Turkey Priva-tization of Irrigation Project, WUAs have the Right and Responsibility to Handle Purchase O&M Equipment. A new aspect of rights to use revenue was introduced in order to promote owner-ship, and to contribute to successful completion of the project. The responsibly for purchasing the O&M equipment was transferred to users, in addition to the common practice of managing O&M only. Thus the main implementation agency is the WUA.

Capacity Building

Seventeen projects included capacity-building-related incentives. Capacity building could ad-dress both users and providers. The majority of the projects with a well defined capacity build-ing component provide training to users and staff for two main purposes: Management of the system (either on-farm irrigation or the tertiary canal), and financisl management of the WUA. No eye-opening cases were identified in the review.

Transfer of Assets

Nine projects included transfer of assets to users. In 7 cases the assets to be transferred include the irrigation system (pond, and canals), and in 2 cases the transfer included canal cleaning equipment and tube wells, respectively.

Some non-specific incentive examples

We have run into several examples of incentives for users that can be imitated to address similar issues elsewhere.

In the Indonesia Integrated Swamps Development Project, an attempt was made to ensuring the payment funds of small farmers. All farmers would receive a one-time grant through their farmer group during the project period in the form of complete input package for 1 ha for 1 sea-son. After the harvest the farmers would deposit the value of the input package in a revolving fund. The revolving funds would be managed by the farmer groups and used to purchase inputs for members during following crop seasons.

In the Peru Irrigation sub-sector project, a one-time matching grant from the government for part of the investment made by beneficiary farmers to modernize their irrigation systems. Beneficiar-ies will contribute 1/3 of the investment. To make sure all farmers have equal access to the grants, they will be allocated proportionally to the irrigated areas. To address poverty -related focus the project will provide 80% matching funds to small farmers and 50% to big farmers (15 ha and more). Farmers that participate will allow extension to use their plots for demonstration.

30

In the Dominican Republic Irrigated Land and Watershed Management Project, During imple-mentation farmer approval would be required for proposed investment and for proposed institu-tional strengthening.

Conclusion on the World Bank Portfolio Review

The review of the active WB’s I&D portfolio revealed that economic incentives are not ade-quately used in Bank projects. Even when used, economic incentives could be better designed to achieve greater impact. Second, as discussed in section 6.4, many of the incentive measures adopted such as water pricing mechanism are not based on the user pays principle (section 5.2) and no measure is yet found on the adoption of pollution charges in the Bank’s I&D projects. Third, how far these incentive measures adopted will help in promoting various facets of WUE is also uncertain in many of these projects.

Likewise, various economic incentives necessitate similar pre-requisites. Thus, joining for ex-ample pricing and allocation of water rights as a set of incentives could reduce the institutional pre-requisite necessary for their implementation. Similarly, transfer of assets, management by users, and capacity building could together benefit from a similar institutional setting necessary for their implementation. However, what we observe is a situation where these three incentives are disconnected, leaving only one of them implemented.

GENERAL CONCLUSIONS, LESSONS LEARNED AND FUTURE DIRECTIONS

General Conclusions

The key conclusions to be drawn from this paper are:

• First, it is clear that economic incentives will have better impact when they are grouped and complement each other and it is being more and more evident that economic meas-ures are an effective policy instrument that may motivate all layers of the sector—government, suppliers, and users.

• Second, many economic incentive measures that do not have a direct and immediate ‘fi-nancial’ input, may produce the needed motivation for the individual or the group to be-come more efficient; and

• Finally, it is clear that the emerging option of delegation of responsibility, to user groups, of allocating water, collecting and handling fees, and even purchasing necessary equip-ment, is used more frequently in water sector reforms.

Lessons Learned

• The first lesson is that WUE need to be defined and adopted in a broader term consider-ing technical, economic, and environmental efficiency of water use. This is also impor-tant for the allocation of scarce water within a region or river basin and regular monitor-ing and evaluation of irrigation projects at the region or river basin level.

• Second, policy intervention at different levels of hierarchy also has different implications on various faces of WUE. While policy intervention at the farm level might contribute toward improving application or end-use efficiency, policy intervention at the regional

31

and inter-sectoral level could help to improve both the allocative and ecological efficien-cies. The lesson learned is that the nature and importance of improvements required in different faces of WUE should determine the scope for policy intervention in a particular region or the project case, and careful integration of economic incentive measures is needed to improve the overall WUE.

• Third, as concluded in section 6.1, various measures – technological, regulatory, mone-tary means and opportunities for developing capacity of the users exist for improving WUE. In practice however, both the adoption and their contribution to the improved WUE are rather limited in the past. The lesson learned in this case is that developing countries should strengthen the existing weak regulatory and institutional structures, in order to promote regulated market and adoption of economic incentive measures includ-ing water-trading mechanism as an effective means for improving WUE.

• Finally, irrigation water subsidies continue to be a popular means of pleasing smallholder farmers in most of the developed and developing countries. Studies however, have shown that the large or medium size landholders and the agribusiness sector are taking more ad-vantage from such subsidies rather the rural poor. The lesson learned is that developing countries can overcome from the poverty trap and make efficient use of water resources by eliminating existing subsidy and introducing economic incentive measures along with development of mechanisms for recycling part of the revenue to compensate the small-holders for the adoption of sustainable water management and agriculture practices.

Future Directions: Some Implications for the Lending/Donor Agencies

• As discussed in section 6.5, the economic incentive measures are not adequately used in Bank projects, and even when used, economic incentives could be better designed to achieve greater impact. This obviously demand a shift in the emphasis from the project-based lending which encourage augmentation of water from new sources to the strengthening of the country/project capacity for implementing economic incentive measures as a source of augmenting additional water supplies;

• As adoption of economic incentive measures for improving WUE is usually an inter-sectoral issue, focus should be shifted towards the policy integration at the sectoral and economy-wide level rather than only on irrigation sub-sector or water sector review as practiced in the past;

• The use of conditionalities in country loan programs for the strengthening of the institutional capacity and gradual adoption of economic incentive measures with follow-up studies and monitoring mechanisms by the Bank and other donor agencies; and

• Development of operational guidelines for the implementation of economic incentive meas-ures at different level of policy intervention (e.g., regional, sectoral, intersectiona l and econ-omy-wide level) for helping decision-makers in the developing countries for making such in-terventions and for facilitating regular monitoring and evaluation of policy performance at dif-ferent levels, and on different faces of WUE.

32

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APPENDIX A-1.0

Glossary of some economic terms used

First-best and second-best settings: The first-best settings refer to the situation where prices or taxes

are determined based on the marginal cost and benefits, or at the level where marginal cost and be nefits are equal. The second-best settings refers to the case, where prices and taxes are not based on the equalization of marginal cost and benefits, but are based on other economic efficiency criteria such as marginal value product of water, full cost-recovery etc.

Marginal costs and benefits: While supplying irrigation water at the farm level, the last unit of

quantity of water supplied is called "marginal unit"; the cost supplying that marginal unit is called marginal cost and the benefits that farmers derive from one marginal unit of water is called marginal benefit. Usually, the supply of additional quantity of water is governed by the cost and the demand for additional quantity of water is influenced by the benefit that a farmer would derive or he/she is willing to pay.

Opportunity cost: The opportunity cost refers to the value of water in its next best

available use and the value attached to marginal unit of water is called "marginal opportunity cost".

Pareto optimality condition: It indicates to the situation in which it is possible to make one

person better-off without making anyone else worse-off. In economic theory, the economic efficiency always refers to the Pareto efficiency condition.

Volumetric pricing: Determination and collection of water charge based on the

quantity of water used rather than on per hectare or per ton of crops produced.

Environmental tax: Environmental taxes are designed on the basis of marginal

abatement cost of environmental pollution (or the cost involved for abating one unit of pollution) and marginal environmental damage (damage estimated from additional one unit of that pollutant). The optimal environmental tax is determined at the point where, both the marginal cost of pollution abatement and marginal damage cost are equal. This optimal level of environmental tax is also called the Pigovian tax, which is considered as one of the economic incentive measure for internalizing the externa lities.

41

Efficient use of Irrigation water Efficient use of irrigation water refers to the provision of

irrigation water to the plants just as much water they need to produce optimal yield, so niether water, not arable land (or labor) is wasted (Schmitz and Sourell, 1998).

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APPENDIX A-2.0

Fig A-2.1 : Different faces of water use efficiency and factors influencing them

Sources of Fresh Transporation/ Water Losses and Different Physical, Agronomic, Economic and Water Augmentation Conveyance System Facets of Water Use Efficiency Environmental Factors Affecting Water

Source, and Water Use Efficiency

* watershed conditionsReservoir * sedimentation * nature of common/system * evaporation Water availabilty state property regimes

* seepage at source/resevoir * existence of river basin*operational capacity level organization

River Run-off-river leakagesBasin/ diversions * topography,

Watershed Main canal + * soil charactersticsLevel system * channel sectionWater Groundwater * evaporation * design velocity

Balance extractions * seepage Conveyance * sediement flow depositsSecondary *operational efficiency * ground water table

canal system leakages * surrounding vegetationWater + conditions

harvestingWater * evaporation * physical factors affecting

Rainfall distribution * seepage Distribution conveyance efficiencysystem *operational efficiency * property right structure

leakages water allocation rules + * organizational capacity

Soil moisture Field application * evaporation conservation and water uptake * percolation Application * field design, soil characterstics

practices by plants * non-recycled efficiency * irrigation application methods surface * crop types and cultivation

Agriculture run-off practices, users' participationproductivity Economic * level of water charges/taxes etc.per unit of efficiency * potential for trading waterwater use

+ * physical factors affecting off-farm Environmental technical efficiency

externalities efficiency * agriculture productivity

Water return to the river/basin (pollutant loads) + * on-farm environmental costs system through S&P & surface run-off * agriculture product prices

Water left in the river system/reservoir/underground to meet the * factors affecting economic ecological demand on-site/downstream Ecological efficiency

efficiency * off-farm environmental costs

* factors affecting environmental efficiency* percentage of water left in the water sources and conserved water available to meet ecological needs

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APPENDIX 2.0 (BOXES)

Box A-2.1 : Reported irrigation efficiency in the developing countries Most of the studies related to the efficiency of irrigated agriculture in the past have reported either on technical efficiency or economic efficiency or in terms of percentage of water loss. In China, the surface irrigation efficiency is reported to be between 30 to 40 percent and canal efficiency between 40 to 50 percent (Qian and Xu, 1994). In terms of application efficiency, total amount of water applied per ha varied from 5,930 cubic meters per ha in Hubei province to 12,000 cubic meters per ha in Southern China in 1989 and 1993 respectively. The irrigation efficiency in Mexico was reported to have declined from 65 percent in 1988 to 40 percent in 1990. In India, the loss of water from seepage in irrigation canals is estimated at 45 percent and in Pakistan, it ranges from 20 to 70 percent. Likewise, in Indonesia poor irrigation infrastructure have caused on-farm loss of almost 50 percent of irrigation water (Yoduleman, 1989). In Ethiopia, water loss in some area have reached to 40 percent, and in Jordan and Sudan, water systems have experienced even higher losses. In Egypt, average conveyance losses between the irrigation outlets and the fields are 11 percent and those between the outlets and main canals are 25 percent (Kirpich et al., 2000).

Box A-2.2 : Other faces of WUE Other faces of WUE than those discussed in section 2, include end-use efficiency, allocative efficiency and institutional efficiency. The concept of end-use efficiency is almost the same as on-farm efficiency, which refers to the total water applied at the root zone. Allocative efficiency refers to the opportunity cost and benefit of water use across different sectors of economy so that no reallocation of property rights would improve WUE without making some one worse off (Young, 1997). The institutional efficiency refers to the capacity of users' groups in the effective management of irrigation water. The WUE is, thus, influenced by socio-technical, economic and ecological dimensions and efforts in improving WUE should consider these various efficiency measures rather than only technical or economic efficiency as focused in the past. Horst and Goodstein (1994) also used the concept of 'static efficiency' and 'dynamic efficiency' in their analysis of impacts of water policy in the Moroccan economy. Measures aimed at improving static efficiency of water allocation such as water conservation, making a shift toward the use of other inputs and new technologies, and development of water market etc., also facilitate inter-temporal appraisal of asset value of water and contribute to the dynamic efficiency. The next widely used concept is basin-wide efficiency. It refers to the percentage of catch-ment yield actually applied to "productive" uses rather than lost to evaporation, unrecover-able ground water, and pollution (Winpenny, 1997). The basin-wide efficiency WUE is in-creased when unproductive evaporation is reduced and when fresh water is prevented from mixing with low quality water (e.g., salt water) by storing floodwater in a reservoir until it can be used (Appelgren and Klohn, 1996, cited in FAO, 1996). At the basin-wide level, in-crease in other types of efficiency such as conveyance and distribution efficiency, some

44

times, may not necessarily add to the basin-wide efficiency as it could be already high as part of the distribution loss could be available for reuse within the basin (Cai et al., 2001).

45

APPENDIX 3.0

Box A-3.1: Examples of adoption of various irrigation water application technologies Examples of the adoption of various technologies for improving WUE are widespread. In Spain, where majority of irrigation lands rely on sprinkling systems, WUE could be widely improved by using dripping irrigation methods (Sanz, 1999). In Muda irrigation system in Malaysia, real time management of water releases from the dam which is keyed to telemetric monitoring of weather and stream flow conditions, has significantly improved WUE and reduced drainage to oceans (Easter and Feder, 1995). A combination of furrow irrigation method with mulch and soil water suction practices could also improve the WUE significantly. Ramalan et al. (2000) reported WUE figures for different practices in the Nigerian Savanna: the conventional furrow method led to the highest WUE of 536kg/ha-cm compared to 372kg/ha-cm in case of alternate furrow methods. The use of mulching practices combined with furrow method resulted in WUE of 538kg/ha-cm. For other type of irrigation technologies such as low energy precision application (LEPA) application efficiency is estimated to be between 86 to 98 percent. However, the application efficiency of some type of technologies such as furrow and ditch irrigation is considered as low as 40 to 60 percent. The rising water costs due to ground water depletion appear to have provided incentive for farmers to adopt the LEPA system (Caswell, 1991). Likewise, cultivation practices such as improved tillage systems affect water use in different ways. Tillage operations affect soil water content, soil water retention and soil water diffusivity, which in turn affect hydraulic process such as infiltration, drainage and evaporation (Bhagat et al. 1996). On-farm WUE can be enhanced both by improved tillage practices and developing practical water application methods for highly water consuming crops such as rice (Abrol, 1999). The conservation tillage which is becoming increasingly popular in South and North America, utilizes both less plowing and crop residue, and to conserve existing soil moisture (Amosson, 1995). It also helps in reducing evaporation, increasing water storage, and finally towards improving WUE (Srivastava et al. 1993).

46

Box A-3.2 : Examples of regulatory measures for improving WUE Regulatory means are especially important, when market or monetary measures fail to take account of full social, environmental and inter-generational costs of water use. They also provide an effective complement to the economic incentive measures. Government regulations can be wide ranging and include both mandatory and enabling measures, for example: • formulation and use of legislative measures in order to reduce institutional, le gal or

economic barriers or to establish barriers against unnecessary water use; • technology-based regulations such as setting up of irrigation water quality standards and

use, which have long dominated as the potential instrument for improving WUE; • land use regulations, for example crop zoning based on land capability and suitability

analysis classifications could also help in minimizing the water use for irrigation; • setting up of uniform charges for covering operation and maintenance costs in order to

finance for minimizing water loss through regular maintenance works. • levying a compulsory contribution from all the farmers to fund for the construction and

maintenance of drainage system for managing drainage water from agr iculture fields.

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Box A-3.3: Examples of creation of ownerships and performance of user groups in different countries

The creation and ownership of water rights form the basis for promoting relationships and co-operation among the users. A decentralized management regime with farmers' participation also helps to promote performance of the irrigation systems in terms of reliability of water supply, and acceptance and payment of user fees (Nagraaj, 1999). For example, water users' association at the Song Nhue scheme in Vietnam, generally, collects 85-100 percent of the amount contracted. The amount payable by farmers also includes additional amounts set by the association in addition to the water price fixed by government, which is in the range of US $10-25 per ha per crop of rice (Stacey, 1999). In Nepal, about 75 percent of the irrigation system is managed by farmers, and in most of cases, water is distributed according to well-defined water allocation rules using traditional temporary check dam structures, which also have proven to be more cost-effective compared to the government managed-systems (Tiwari, 1987). In Taiwan, where irrigation systems are considered most efficient, the capacity of water user groups is considered to be a major contributing factor to the increased effic iency rather than the physical infrastructure (Wade, 1995). However, some countries still prefer private management and operating concessions, with assets remaining in the public domain. For example, the French water management, helps to keep a sanction against an unsatisfactory operator (Winpenny, 1996). Similarly, Easter (1999) reviewed the successes (failures) of WUAs in several Asian countries. As a percent of cost-recovery, WUAs collect 65 percent of fees in the Philippines, 70 percent in Andhra Pradesh (India), 50 percent in Nepal, 79 percent in Indonesia, and 68 - 100 percent in Pakistan (Easter, 1999, cited in Johansson, 2000).

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APPENDIX 4.0 (FIGURES)

Fig. A-4.1: Driving factors, scope of policy intervention, implementation means for Improving different faces of WUE at different levels of hierarchy

Major Driving Institutional Responses Potential ImpactsForces/Factors

Scope of Policy Means of Faces of WUEIntervention Implementation Likely to be Addressed

* Reservoir siltation/reduction in water * Adoption of socio-technical water storage capacity approach for improving * Lack of equitable distribution of water systemwide management Storage

among different subsystems * Improvements in reservoir efficiency* Underpricing and lack of proper opertn. and canal system to minimise and maintenance at main system level different types of losses Conveyance

* High level of conveyance losses * Development of decentralized efficiency systemwide organization

* Use of inefficient technologies and * Quota allocation and Distribution

wasteful use of water at the farm-level systemwide trading efficiency* Excessive use of other chemical and * Water abstraction charge and energy inputs at the farm-level limits on water withdrawl

* Watershed degradation* Increased flood frequency/droughts * Formation of river-basin level that affect the users' capapcity to organization with well Basin-wide

manage canal systems decentralized structure efficiency* WUAs sharing water from the same * Recognition of water as part river or tributaries and conflicts in of national wealth and Allocative

sharing water re-allocation of water rights efficiency* Over exploitation of both ground and * Water pricing based on MOC surface water/decrease water balance * Introduction of quota allocatn. Ecological* Increased water pollution/ecological if market not well developed efficiency

degradation/vector-borne diseases * Allocation of water for environmental purposes

* Increased conflicts in water sharing at sectoral level e.g., for irrigation and * Marginal cost pricing drinking water supplies and hydropower * Water trading mechanism Conveyance

* National priority for food security * Decentralization of water efficiency

and rural employment generations services* Over-centralized structure and * Clear definition of water rights Application

lack of decentralized management and water allocation for efficiency

* Distortions in agriculture markets irrigation and drinking water and subsidy for water purposes in case of droughts End-use

* Policy integration at sectoral efficiency level

* Increasing water scarcity and conflicts in sectoral water allocation * Development of inter-sectoral* Lack of inter-sectoral coordination water allocation and trading Allocative

for equalizing marginal benefits of mechanisms efficiency

water across sectors * Computation and implementn.* Impacts of water allocation on food of marginal opportunity cost End-use

security and the rural poor pricing across sectors efficiency

* Lack of clearly defined property rights * Compensation mechanism for and limitations on water trading the poor segment of the Ecological

mechanisms population efficiency* Safeguarding agriculture productivity when necessary

* Economywide policy adjustments and * Integration of water policy budget deficits with economywide policies Allocative

* Transboundary water conflicts * Removal of perverse subsidies efficiency* Obligations to the provision of GATT and adoption of environmental rules on ATL friendly subsidies for Economic

* Increased rural unemployment, poverty adoption of water-efficient efficiency and food insecurity technologies

* managing policy reforms for Ecological implementing various efficiency

economic based measures

Regional Level

Sectoral Level

Inter-sectoral Level

Economy-wide Level

Farm level vswater-supplier

level

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Box A-4.1 Regional level policy intervention and trans -boundary allocation of water resources

Policy intervention at the regional level allows for resolving trans-boundary water sharing conflicts. The nature of policy intervention at the regional level is guided by the cooperative mechanisms developed between or among the groups of countries sharing water from the same river basin. For example, in drought prone Southern Africa, countries have developed basic governing principles and laws for managing water in a manner that optimizes benefits to all the parties, and allocation is done with due recognition of the dow nstream country users (Conley and Nierkerk, 2000). The bilateral agreement between Bulgaria and Greece allows inter-country allocation of fresh water resources and the two countries charge the same price to all users in a given sector (Ginanias and Lekakis, 1996). The Strategic Action Plan developed for sharing the Danube River water among the countries in the Danube basin clearly defines scope and possible actions related to policy, legal and regulatory measures for implementatio n at the regional level by member countries (Nachtnebel, 2000). Other examples include water sharing and water policy arrangement in the Nile river basin (Allan, 1990), between Syria and Turkey in the Euphrates river basin, and Lesotho and Namibia in the Orange River case (Conley and Nierkerk, 2000).

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Box A-4.2 : Linkages between water policy reforms and economy wide policies A few studies carried out in some developed and developing countries highlight on the linkages between the economywide policy reforms and the water policy reforms, in a general and partial equilibrium framework. Berck et al. (1991) measured the impacts of water transfer from agriculture to other sectors in the San Jaoquin Valley, USA, with application of computable general equilibrium (CGE) model. The result indicated that water transfer from agr iculture to non-agriculture uses could decrease by 20 percent and the displacement of about 5,000 agriculture labors with loss in farm income at the range of $ 100-200 million. They also showed that the loss could be compensated by the sale of water. The next study on the impacts of water pricing policy in Mexico (Goldstein and Roland-Horst, 1994), indicated that, if water price reforms were undertaken in combination with trade policy refor ms, the medium term effects on income would be more than offset. The rural, urban and aggregate real income would rise substantially while still achieving substantial water savings. The combined policy could move the economy onto a path, which is more sustainable. The impact of development in water market and inter-sectoral allocations on the economy is also mixed. While development of water market may provide opportunity to farmers to trade water at relatively higher prices, inter-sectoral allocation or reallocation of water away from the agriculture sector could have some negative impacts on rural economy due to reduced employment opportunities in the agriculture sector (Rosegrant and Ringler, 1998). On the contrary, Diao and Roe (2000) examined the effects of a water user-rights market on the economy wide indicators. The results indicated mainly positive impacts, for example, impacts on the rural employment. Efficient use of water as a result of market-based policy intervention could increase marginal value product in the fruit and vegetation sectors, and could result in modest increases in the rural wages. But returns in non-irrigable lands could suffer, since they would have to compete with the more competitive irrigated sector. As a result, employment opportunities in the rain-fed agriculture sector could be slightly affected. Likewise, Berbel and Gomez-Limon (2000) in a study of impacts of pricing policy reform in Spain showed that agriculture income could decrease between 25 to 40 percent, leading to significant loss of rural employment opportunities, and reduction in fertilizer use before water demand starts to cease significantly.

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APPENDIX 5 (TEXTS AND FIGURES)

A-5.1 Basic concepts and issues in water pricing The relation between different incentive mechanisms and efficiency measures can be explained with the help of marginal benefit (MD-demand) and marginal cost (MC-supply) curves as shown in Fig. A-5.1. Some form of water pricing exists in most of the countries, but usually are introduced to cover the operation and maintenance cost, and is set out below to determine the optimal price. This could be considered as a initial price, and it is denoted by p0 in Fig. A-5.1. Given the demand curve DD’, q0 level of water is demanded and used by the farmers. In such a case, if the generated revenue is invested in canal maintenance works, it could reduce seepage and percolation loss and could im-prove technical efficiency. However, as the price is set below the optimal level, it would not help to change farmers' behavior and the government may have to intervene and charge at a level where the marginal cost and marginal benefit is equal. In the figure, this optimal charge or price is denoted by p1opt., and the corresponding water use by the farmers by q1opt., where the subscript opt. stands for op-timal level. By increasing the water price WUE is achieved equal to the difference between the ini-tial level of water use (q0) minus the optimal level of water use (q1opt.) and divided by the initial water use q0. At this level, while the government or the society gains in terms of savings in water use, farmers may loose due to reduction in water use. In economic terms (i.e., water quantity multiplied by the water price) the society gains an amount equal to the area 'omp', and farmers' welfare is re-duced by area equal to 'gomph'.

Fig. A-5.1 : Water use and Economic Efficiency

MED = marginal environmental damage cost, MC = marginal cost, MB = marginal benefit

water price D B' MC curve with ($/m3) MED

p1 j k p A' MC curve p2opt. I l

p1opt. h m

p0 g n o B D' MB curve A

r

q1 q2opt. q1opt. qo water quantity (m3)

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In theory, various economic incentive measures can be adopted for improving WUE in the first and second-best settings (for definition of terms see A-1.1). For example, direct water pricing based on the volume of water consumed designed on the basis of marginal cost pricing rule (p1opt.) as shown in Fig. A-5.1. Water pricing below marginal cost, or adjustments in output and other related input pricing could only partially achieve efficiency in the second best settings as they are not directly related to the per unit water use. The difference between marginal cost of supply and what farmers actually pay per unit of irrigation water is considered as subsidy and this is shown in Fig. A-5.1, as the difference between optimal price p1opt. and existing below full cost price p0. Provision of water equal to the difference in quantity between (q0 – q1opt.), thus has high societal cost and such costs add up to millions of dollars per year both in developing and developed countries. In the case of environmental damages, the marginal environmental cost, if included, it will push the supply curve as shown by the line BB’in Fig. A-5.1. In this case, other things remaining constant, it will result in a new equilibrium at a point 'h' where the resulting water price and water quantity consumed, is determined at the level p2opt. and q2opt. The difference in the price (p2opt – p1opt) is usually charged to the users by means of a water tax, an environmental tax. A tax incentive equal to this difference could be designed and implemented so that the water price also reflects the environmental damage cost. Likewise, an implementing agency could also fix the quota for water allocation instead of imposing a tax, for example, at a level equal to q1opt. The price in this case is determined by the market conditions, instead of regulation of price at the level, where marginal cost and marginal benefit are equal. The optimal price under the quota system could also depend on the marginal benefit of water use in other sectors rather than only in the irrigation sector, and is considered to be an efficient measure for achieving allocative efficiency (for example, see Mohamed and Sevenije, 2000 for detailed discussion on quota allocation and water use efficiency). Text A-5.2 : Cause and effect linkages of environmental taxes and resource

use efficiency The potential adverse impacts of economic incentive measures such as introduction of environmental taxes or removal of perverse subsidies have been a major issue of concern in the developing countries mainly for two reasons. The first is due to the misunderstanding of the linkages between economic policy measures, the national economy, and the environment. The second reason is the fear of loosing competitive position in the world agriculture market due to the implementation of these measures. The general hypothesis is that the introduction of user charges and environmental taxes would raise the production costs and hence export prices, which could affect or alter country's competitive position in the international market. Fig. A-5.2 illustrates the cause and effect linkages between economic incentive measures, such as: envi-ronmental taxes/charges, resource use efficiency, producers' profit, and government revenue and trade/fiscal balance, etc., which could help to conceptualize both the potential costs and benefits of eco-nomic incentive measures. In a closed-loop diagram (characterized by several positive and negative loops as indicated by different letters), environmental tax is introduced as a means for improving water use efficiency and internalizing environmental damage costs of irrigated agriculture, and making a shift towards adopting resource conserving/sustainable agriculture practices. The potential effects in the short-run could be both negative and positive on the resource use efficiency, producers' cost, trade and fiscal balance as shown by the positive (+ sign indicating negative impacts with widening effects) and negative (-ve sign indicating positive impacts with self stabilizing effects) feedback loops. In the long

53

run, the system may however, adjust and will be in general equilibrium, and that unlike price alone, re-source use efficiency and environmental qua lity would drive the economy to a sustainable development path. These various feedback loops are brie fly explained in order to help conceptualize the cause-effect linkages in terms of costs and benefits of the introduction of economic incentive measures, such as the environmental tax. Cost loops Ø the conventional wisdom that - a rise in agriculture input prices as a result of internalization of

external costs, the production costs and consequent changes in the export price of the product - form the cost loop (C), in Fig. A-.5.2. There can be some cumulative effects on the export prices through the impact of taxes on production costs. The combined effect could result in widening of the costs of production, thus supporting the general hypotheses of loosing competitive position in the global market; and

Fig. A-5..2 : Cause and effect loops showing linkages between economic incentives

(environmental tax), resource use efficiency and the Economy Ø the polluting environment itself, however, results in direct costs and benefits to producers through

induced changes in the labor productivity. The cost, however, is not usually incorporated into the producers’ cost, or the export price. If considered alone, its impact in the long run may be widening as shown by the positive sign of the loop (B).

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Benefit loops

The introduction of economic incentives such as environmental taxes can provide benefits in several ways: Ø increased investments in clean/efficient technologies could promote sustainable resource use

practices, which could increase producers' profits through increased agriculture productivity, and reduced production cost. If producers' cost due to introduction of the environmental tax is minimum then, it will have widening effect on the producers' profit in the long run as shown by the loop (A) in Fig. A-5.2;

Ø even if presumptive Pigouvian tax is imposed instead of charging pollution directly, it will increase

the energy price. But increase in energy use efficiency could provide benefits in two ways: i) reducing the production costs, and ii) decreasing the volume of imports of polluting inputs thereby decreasing the trade deficits. The negative loops (D, E and F) indicate that it will lead to a self-stabilizing situation in the long-run as improvement in environmental quality will also result in the reduction of pollution and finally, lower charge on the environment;

Ø when the generated revenue is used either for export tax cuts or investing in clean/efficient

technologies, thereby helping in lowering down the prices of the exportable commodities, people could suffer due to introduction of environmental taxes, but the situation is self-stabilizing in the long-run as shown by the negative loop (G);

Ø the use of government revenue for research and development of water-efficient technologies and

practices can also have indirect, but positive effects on trade balance due to availability of clean/efficient technology/practices at home. This is rather a long-term proposition, and the costs of research and development will have to be compared with the costs of direct imports of such technologies.

The overall effect would be welfare increasing, if the impacts of irrigated agriculture on the environment and human health are also taken into account. In this case, investing in the water and energy efficient technologies by recycling the tax revenue could offset the fear of trade deficit or loosing competitiveness. The implication for policy intervention then is how to pursue complementary policies or adopt integrated approaches in line with the negative feedback loops (with positive impacts) so that the widening effects on the production costs, if any can be reduced. Economic incentive measures aimed at improving WUE, thus should be implemented using an integrated approach that aims at changing users' behavior for water conservation through changes in price, tax, property rights and quota system, etc.

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Box A -5.1 Further issues in the design of water pricing systems There are several issues involved in the design of water pricing systems aimed at improving different faces of WUE. The first issue relates to the basis for pricing irrigation water. From the standpoint of economic efficiency , water price should relate to the marginal cost as explained in Appendix (Text A-5.1). From the allocative efficiency viewpoint, the price should be based on the opportunity cost of water. From sustainability or ecological efficiency viewpoint, the price of the natural resource (water) should reflect both the environmental cost involved and the benefit forgone in future from using a resource today (Pearce and Warford, 1993). For successful implementation of water pricing mechanism, water price should be based on the farmers' willingness to pay (WTP), and as evident from the farmers' and government ma naged irrigation systems, farmers' WTP depends on the nature of the property right conditions (Tiwari, 1998, 1993). From political economy considerations, the inc idence of costs and benefits of pricing measures across different income groups, especially on the poor should be as low as possible (Tiwari, 2000b). Uniform water price based on the marginal cost irrespective of the land size could have negative impacts on small farmers. For example in Bangladesh, small farmers paid 25 percent higher charges and 110 percent higher wages than large landholders. The case was more severe where land was rented because the farmers paid almost 50 percent of the gross produce as rent (Yoduleman, 1989). The next concern is that volumetric pricing often involves high transaction costs due to monitoring, measuring and collecting water charges, which sometimes could exceed the benefit over the reduction in water use (Nickum, 1998). Application of marginal cost pricing requires large information for the computation of marginal cost, which also varies according to the season (e.g. off-peak and on-peak) and period (e.g., short-run and long-run marginal cost) (Spulber and Sabbaghi, 1994; cited in Dinar et al., 1997).

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Box A- 5.2 Water pricing system and efficiency gains Dinar and Saleth (1999) summarize the implementation of water pricing system by grouping about 22 developed and developing countries studied in three sub-categories. The first group includes most of the developed countries where some level of economic pricing mechanism has been introduced. In the second category, are economies in transition or some large producers such as India and Brazil, where water pricing has been introduced with the aim of covering operation and maintenance costs and some cost recovery. The third category includes countries, where some attempts have been made to introduce water pricing in order to cover operation and maintenance costs. In Germany, water charges have been effective in raising revenue, but charges are too low to affect the farmers' behavior. In Israel, where the irrigation water price is close to the marginal value product, efficiency gain was evident: a 50 percent reduction in water use was reported after improvements in water pricing system. Water allocation to agriculture declined signif icantly from 74 percent in 1986 to 62 percent in early 1990s and productivity gains were also realized as per unit of land has doubled during the same time. In case of Netherlands, the experience was mixed as there was improvement in water quality with the introduction of water charges, but no reduction in water use was reported. In Spain, the effect of pricing policy was uncertain, but has encouraged the farmers to save irrigation water (Sanz, 1999). In France, the tariff structure for irrigation water determined separately based on off-peak and peak costs. The peak period for irrigation lasts for five months from mid-May to mid-September and the water tariff during this season reflects the long-run marginal costs including the operating costs. During the rest of the year or the off-peak season, only the operating cost is included in the tariff structure. This dual pricing structure has helped to use scarce water more efficiently during the period when the demand is high compared to the supply. The higher Source Saleth and Dinar (1999); Sanz (1999); RPA (1999), Ahmed (2000).

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Table A-5.1 Numerical illustration of farmers', government, and societal loss/gains at different water fees level ($/ha/year) in Phlaichumpol Irrigation sub-Project, Northern Thailand.

Cases Farmers' Government Societal LossLoss/gain Revenue (-)/gain(+)

1. Water fees without transfer 230.75 (-) 26.0 plus (-) 153.0of water rights ($24.25/ha/year) administration

costs2. Water fees with transfer of 145 50.25* (-) 99.75property rights ($87.0/ha/year)

3. Water fees with incorporationof environmental costs at:($84.25/ha/year)** 147.75 84.25 (-) 40.25

($147.0/ha/year)*** 85 147 (-) 40.25

* Rest is supposed to be retain by the farmers' organization** $24.25 (Willingness to pay value) + $60.0 (environmental costs)*** $87.0 (marginal value product of water) + $60.0 (environmental costs)(Source: Tiwari, 1998)

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Box A-5.3: Advantages and disadvantages in output pricing There are several advantages of the output pricing system in terms of ease of impleme ntation. One of the advantages is that it is easy to measure per ha crop productivity on which, the per unit price depends than measuring water volume at each farmer's plot. Likewise, output based pricing could also help in promoting the adoption of alternative cropping systems with less water requirements, utilization of wastewater for agriculture, and adoption of new irrigation technologies (Kirda and Kanber, 1999; Palanisami, 1999, cited in Johansson, 2000). Given the level of water charge based on the output, farmers' would either try to use available means for maximizing the profit, or switch to other crops when cultivation of a high water consuming crop would no more be profitable to them. One of the examples on how output pricing could affect the crop diversification is evident from a case of banana in Jordan. If the import ban on banana is lifted, then such a policy could increase supply of banana, which will result in, the decreased price of banana in the market. In such a case, farmers will have to diversify crops because producing banana would no more be profitable with increased water price (Shatanawi and Al-Jayousi, 1995).

Box A -5. 4: Basic issues in the implementation of subsidy scheme for improving WUE When a government’s national interest is to increase water available for certain sectors or citizens , it is often necessary to provide water at a subsidized rate or introduce differing pricing mechanisms that account for disparate income levels (Dinar, Rosegrant, and Meinzen-Dick, 1997). For example, in China, capital intensive application methods such as drip and sprinkler are already adopted in about one-sixth of cultivated lands and the problem in expanding these technologies is that their expense is often well above the low price charged for agriculture water (Nickum, 1998). Likewise, in Bangladesh, the groundwater market seems to be highly monopolistic, because, the market deve lopment is seriously constrained due to unavailability of credit to the small and marginal farmers would not be able to compete if no credit facilities are provided (Fujita and Hussain, 1995). In such cases, subsidies for adopting these technologies could help improve WUE. Several issues are attached in the design and implementation of subsidy measures as they also go against some provisions of agriculture trade liberalization under the WTO, and add fiscal burdens on governments. Under the GATT rules, subs idies should not be misused as another way of providing support to the farmers that distorts agriculture price and trade. It should rather directly be related to the efficiency gains in water use rather than relating to the cost of technology. Although environmentally friendly subsidies have been introduced in Western Europe and the USA, such as for land set aside and Conservation Reserve Programs (CRP) (Box A-.5.5), the economic approach adopted has been highly criticized (Runge, 1994). There is need for a shift from marginal cost based approach to social marginal benefit based approach for compensating or subsidizing the farmers for encouraging them to use water efficiently. Direct subsidy in cash payments should actually be provided only to those farmers, who are forced to pay high water charges or taxes compared with their ability to pay, and should be designed on the basis of net societal gains that result from the reduction in water use.

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Box A-5.5 Examples of environmental subsidy programs and implications for reduction in water use The provision of direct subsidy for environmental improvement is quite rare. Instead, there has been a gradual phase out of subsidies on agriculture inputs such as water, fertilizer and pesticides, which have shown high efficiency gains both in the deve loped and developing countries. The land set-aside program introduced in Western Europe and Conservation Reserve Programs practiced in the United States, are two of the measures, which provide direct subsidies to farmers. Both these programs could have positive impacts on water use, as the major objective is to reduce the area under cultivation and land conservation. The Conservation Reserve Program (CRP) under which farmers agree to retire eligible lands for 10 years in exchange for annual payments, plus cost sharing to establish land cover with grasses or trees, now sets aside about 30 million acres of environmentally vulnerable land in the United States. This could have signif icant impact on the water use, if taken out from the irrigated lands, but the cost itself is quite high, which is estimated at about $2 billion a year. Obviously, such programs and even subsidizing the adoption of technology would take large portions of the development budget and increase fiscal deficits and food scarcity in developing countries. Another approach, which could have some impact on the reduction in water use, involves compliance schemes. Under this scheme, to receive payments from certain agricultural programs, a farmer must meet certain conservation standards such as leaving a minimum amount of crop residues. This is being implemented on nearly 150 million acres of land that is prone to high erosion in the United States. Retaining crop residues in croplands also helps in soil-moisture conservation, leading to less water demands for crop irrigation. (Source: Ervin, 2000)

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Box A- 5.6 : Water abstraction charges and reported improvements in WUE Few countries have actually imposed water abstraction charges, and not much information is available on the impacts on reduction in water use. The water abstraction charge in France is 0.01 – 0.02, Germany 0.02 – 0.53, UK from 0.006 to 0.021, and in Netherlands at 0.08 and 0.15 ecu per cubic meter at provincial and national levels. In Denmark, under the green tax reforms program, the water tax is imposed at 1-5 DKK per cubic meter at 1998 price. However, farmers can deduct this tax for their VAT proceeds (Krinner et al., 1999, OECD, 1998). The effectiveness of water abstraction charges practised in these countries is yet to be known. In general, the adoption of abstraction charges has resulted in the shift from ground to surface water. The introduction of the charging scheme for groundwater in Hamburg has resulted in a significant return of unused water rights - one of the main aims of the scheme. Whereas in Hessen, Germany, which levies the highest charges, a reduction in water consumption by 11 percent has been reported although some of this reduction may be the result of the slowdown in economic activity. In the Netherlands, the New National Groundwater Tax together with the existing provincial groundwater charge could probably be sufficiently high to provide some incentive to use less water (Krinner et al., 1999). Smith (1995) indicated that though these charges would have helped for efficient water use to some extent, the charges or taxes do not incorporate the external cost generated from the water abstraction.

Box A-5.7: Some additional issues involved in the design of taxes for water abstraction The implementation of abstraction charge requires volumetric measurement of water to define the total annual licensed volume of abstraction. As the contribution of ground water abstraction to the total fresh water augmentation and externalities generated through irrigated agriculture practices, highly varies according to the locality, the unit charge could be based on the extent of the location or region specific impacts. In order to have effective abstraction charges or taxes, the charges on actual abstraction need to provide an incentive to abstractors for reducing use and the external cost of abstraction. Other factors to be considered are: • the volume abstracted in relation to the river flows or ground water capacity and recharge

rates, the point of abstraction and timing, location of any returns of the water and opportunity cost of water.

• Potential impact on the environment of any changes in abstraction rates which needs to

take into account the local catchment and regional conditions, • Quality of return flows; The problem faced while applying these concepts in developing countries is that they require serious efforts in information collection and sound monitoring systems inclu ding water-measuring devices.

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Box A -5.8: Water Charges in France: Use of both UP and PP Principles In France, the six Water Agencies implement the ”polluter-pays” (PP) and ”user-pays” (UP) principles, and collect, financial charges paid by various categories of water users (local authorities, industries and farmers who irrigate) for water abstraction and consumption, pollution of water and modification of the hydrological regime at the catchment level. The funds collected are reallocated to provide financial assistance to reduce pollutant discharges and in a general sense to improve water management. Regarding the water abstraction and consumption scheme, charges are based on the volume abstracted and used, the scarcity of water resources, and how much water is returned to the environment. Charges are generally higher for water taken from upper reaches of rivers, which tend to be less polluted. In addition, charges for groundwater tend to be higher than that for surface waters. Source : Krinner et al. , 1999.

Box A-5.9 : Use of taxes on water pollution and related inputs, and reported efficiency gains Some developed countries have already introduced tax measures for controlling pesticides and chemical fertilizers. For example, Denmark, Finland, Norway and Sweden have introduced taxes on agricultural inputs such as fertilizers and pesticides. In Denmark and Norway, the retail sale of pesticides is subject to taxation at 20 and 13 percent, respectively (OECD, 1996). The performance of these market-based measures is visible in the declining use of chemical fertilizer per ha of cultivated lands. In one German State (Baden-Württemberg) the funds raised are used to compensate farmers for the effects of reduced fertilizer use and the application of more expensive, but environmentally more acceptable, pesticides. Source: Krinner et al., 1999; OECD, 1996.

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Box A .5.10: Some additional issues involved in the implementation of quota system Additional conditions requiring the successful implementation of quota system, include: the need for maintaining minimum flow of water in the canal system for downstream users in the case of droughts, and institutional arrangements in order to avoid monopolistic situations, where large landowners could monopolize the water entitlements. Second, if the quota systems are binding, raising irrigation water prices does not necessarily increase water productivity and efficiency, and thus may be merely a tax, especially on efficient farmers (Amir and Fisher, 2000). Third, as Howe (1996) pointed out, there are economic limits to the public purchase of water rights (under the trading system) when social and cultural goals are sought. The small farmers are often victimized as they face difficulties in acquiring quotas and trading them. In such situations, regulatory measures to protect the smallholders' rights may be necessary. Third, the transaction cost involved in the enforcement of quotas is also reported to be very high. For example, in Queensland, Australia, transaction cost is reported at A$ 100, 150 and 200 for the first, second and third transactions respectively. In Victoria it is reported to be A$ 70 per transaction. In Mexico, the transaction cost is fixed and does not vary with changes in water volume. In South Africa, transactions took some 3-6 months time and cost to the sellers was R200 to R600 per transaction. To buyers it ranged from R2000 to R6, 000 (RPA, 1999). Finally, if the quota allocation do not address the ecological limits of water abstraction and use, over extraction and use of river and groundwater could have serious ecological impacts. The water demand for maintaining ecological integrity does not enter the market. Except for recreational demand, other types of ecological demands possess non-use values and public intervention is necessary in terms of quota restrictions to meet these demands (Howe, 1996). As a rule of sustainability, allocation of quotas and trading between sub-catchments should be managed via a series of measures that allow for minimum evaporation, loss to groundwater, effects of the trade on environmental flows, etc. (Young, 1997).

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Appendix A-5.11: Application of fixed quota system for irrigation water use In some countries, like New Zealand, the provision for fixing quota system for water abstraction for irrigation purposes is made in the National Water Act. For example, within the Riet River and its tributary the Modder River downstream of the Krugersdrift dam, the Act outlines the need for curtailing to 35% of the full quota delivered from the Krugersdrift Dam (National Water Resources Department, New Zealand) 25. In Tejinin province in China, water quota system is well defined and allocated based on the water requirements per unit of agriculture area. The arrangement of reasonable irrigation quota for crops allocated for the eight river basins and regions in the province are based on the estimation of crop water requirements, effective rainfall and run-off and potential water deficits. The actual water requirement quota varies from 3082.5 m3/hm2 to 7411.5 m3/hm2, whereas the reasonable quota fixed varies from 3900 to 7500 m3/hm2. The current irrigation quota varies from 5149.5 to 11493 m3/hm2 (Chuanyou, 1999).

25 Ministry of Water resources and Forestry, New Zealand. National Water Act (1998), Notice No. 799 of 1999.

Limitation on the Abstraction and Use of Water for Irrigation purposes , web page: www.acts.co.za/Ntl-water/No-799-0.htm

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Box A-5. 12 : Trading of water rights and efficiency gains One of the basic aims of allocating property rights in the context of changing demand patterns is to provide incentives to users to trade water in order to maximize the net benefits. Users would not only be encourage d towards water conservation, but would also trade the surplus or conserved water within themselves and with other sectors and receive higher economic benefits. The successful trading of water takes place through the creation of Water Users’ Associations (WUAs) as has been done in Me xico, where users are granted rights for water use and use of irrigation infrastructures. In addition, they need to be provided certainty in user rights by creating a Public Registry of Water Rights and be allowed to transmit the rights between users within the same basin or between those who make the use of the same water source or aquifer (Klozen, 1998). On the other hand, water markets also help users to allocate the scarce resource more efficiently, and diversify crops. Some form of water trading system, whether formal or informal, exists in many deve loped and developing countries. In terms of efficiency gains, evidence of transfer to higher value uses, and incentives for efficiency gains, have been reported in Chile, Mexico, and South Africa. In South Australia, the value of marginal units of water was reported to have doubled. In Colorado, USA, some increases were reported in crop pr oduction while in Idaho efficiency gains were limited as prices were kept low. In California, water-trading has appeared to be a politically acceptable method of allocating water in times of drought and in India and Pakistan, access to water resources has been made easier especially for the land-poor. In Oman, efficiency gains were limited as water trading was taking place within the irrigators' community only. In Spain, water-trading system resulted in higher net returns compared to the rotation systems used elsewhere (Sanz, 1999). In India, there are different types of groundwater market arrangements, such as those in Gujarat and Periyar Vegai basin (Dinar, Rosegrant, and Meinzen-Dick, 1997; Saleth and Dinar, 1999). The advancement in the water market in Gujarat, has increased farmers' investment in modern water abstraction mechanisms and on conveyance structures which have helped increase WUE. In some locations, water transfers to the rain-fed areas and the intensive year-round cultivation due to groundwater transfers has also increased employment, at least, by three times and reduced seasonality in farm employment. Other potential gains of water trading system in general include: i) new users gaining access to the resource; ii) existing users realizing the value of efficiency gains in water use; iii) users' entry/exit to the water industry through purchase/sale of their license; and iv) government entering the market to acquire water licenses and subsequently, reallocate them or retire them.

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CASE EXAMPLES

Example 1.0: Water pricing reforms and water trading in Murray-Darling River Basin,

Australia The water pricing policy reform in Australia, which began in 1992, resulted from pressure for general economic policy reforms. In February 1994, the government developed a strategic framework and introduced the concept of "full economic costs” in determining the water price with consideration of environmental costs as well. As a result, the water charge increased by 35-50 percent. Additional measures taken included the removal of cross subsidies, clear definition of water rights in terms of ownership and constraints on transferability and resource use or access. These various measures combined with the allocation of tradable water rights also helped to promote water trading and improve economic and distribution efficiency of water use. For example, available information from Murray-Darling river basin indicates that these various economic incentives measure and regulations helped to reallocate water within the irrigation sector and transfer of water from low to high production value. The distribution efficiency is also expected to increase by about 8 percent. In New South Wales, the volume of water traded on temporary basis varied between 200,000 Ml and 700,000 Ml, which represented about 10 percent of the licensed volume of water extractions from regulated streams. Likewise, the ecological efficiency is also expected to improve as a result of the cap put on water withdrawal from the water source. The provision made restricts the future extractive usage of water while allowing for adjustments for annual stream-flow and climate changes. The provision also requires at least 5 percent of total discharge available to be left over in the water source for maintaining ecological life downstream. [Source: Crase et al., 2000; Pigram, 1999; Saleth and Dinar, 1999]

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Example 2.0: Water pricing combined with quota allocation system: The case of Israel In Israel, water-pricing mechanism is combined with the water quota system and the water charge is set according to the level of water use. This tier pricing system introduced during mid-1970s and abandoned in 1977 due to farmers' political pressure, was again re- introduced in 1989. Under this pricing system, farmers have to pay US$ 0.16 per cubic meter for the first 50 percent of their quota, US$0.19 per cubic meter for the second thirty percent and US$0.26 per cubic me-ter for the final 20 percent (1995 price). As farmers using water more than their entitlements have to pay more for the use of excess amount of water, this has encouraged both water conser-vation and inter-farm water transfers. This progressive block tariff also increased water produc-tivity in agriculture by 250 percent and helped to transfer some rents from water suppliers to the farmers. As farmers' share to the cost of water supply was still limited to 65 percent of the mar-ginal cost of water, the Israeli Government further amended the water pricing policy in 1999 to reflect the scarcity value of water. (Source: Yaron, 1997, Dinar and Subramaniam, 1998, Saleth and Dinar, 1999).

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Example 3.0: Irrigation management transfer for providing economic incentives to farmers

for sharing water supply cost in Mexico In Mexico, while farmers' contribution to the water supply cost was more than 85 percent during the 1950s, it reduced to less than 20 percent over 30 years period by the early 1980s. The main reason was the low water fees collection combined with the escalating costs of provision of irriga-tion water. To avoid this situation and encourage farmers' participation in sharing the water sup-ply cost, the Mexican government introduced a new Agrarian Law in 1992 and also instituted a program to transfer management responsibility from the National Water Commission (CNA) to the water users. The revised Agrarian Law, thoroughly redefined land property rights, transfer of property rights and provided the legal framework to allow the sale of water to higher value uses. Under these provisions, while farmers hold rights for water transfers within the sector, those seek-ing inter-sectoral water transfer are required to take prior approval from the concerned authorities. Next, the new Law also facilitated automatic collection of irrigation water fees based on the volumetric use and users are supposed to present the receipt of water fees payment to the ditch tender, who in turn would schedule delivery of their water. By 1998, more than 91 per cent of the 3.3 million hectares of publicly- irrigated land had already being transferred to joint management, and seven Limited Responsible Societies (LRSs) were created comprising about 705 000 hectares. Though direct impact on WUE of the IMT program in Mexico is not reported, available informa-tion indicate some improvements in the overall performance in managing irrigation water. In Mexico, during early 1990s, water conveyance losses were estimated at 40 percent in gravity-based schemes, farm-level losses at 30-40 percent and overall WUE at 30 percent which was quite low. With the management transfer, water delivery to the field and hence relative water sup-ply (defined as the ratio of total water supply to total water demand at the field level), increased to 2 percent indicating adequate supply of water to meet the demand. Consequently, the equity in water distribution and output per unit of water were reported increased after the management transfer. Likewise, while farmers’ were paying only about 25 percent of operation and manage-ment (O&M) cost, their share to the O&M costs increased to 90 percent after the management transfer. A few other case studies on IMT, provide some examples on the direct reduction in water use as a result of the IMT program. For example, drawing data from 29 case studies on IMT in different countries, Vermillion (1998) indicated that in Vietnamn and Nepal case studies, the water con-sumption was reported reduced by 36 percent per ha and by 50 percent respectively, after the irri-gation management transfer. [Source: Johnson III, 1997; Kloezen, 1998; Klozen et al., 1998, and Ringler et al., 2000]

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Example 4.0: Economic incentive measures in China: A case of policy failure In China, farmers are increasingly facing high scarcity of irrigation water due to growing water demand in domestic, commercial and industrial sectors. The increased reservoir siltation and de-creasing water flow in the rivers have also worsened the situation in many provinces. The WUE is reported to be between 40 to 50 percent and is considered very low. Irrigation projects those constructed in the 1950s and 1960s are no more operating effectively and there is continuous de-cline in irrigation benefits, which has a direct impact on the sustainability of irrigated agriculture in China. Although China introduced water fee collection system in 1978, it was legalized only in 1984. The Water Law enacted in 1988 established some guiding principles, which included es-tablishment of water as peoples' property, and called for the permit-based water allocation and full cost-based water charges. Available information, however indicate a number of deficiencies in the institutional design and making improvements in WUE showing a case of policy failure in managing irrigated agriculture in China. These are: ♦ water fee criteria being highly lower than the actual water-supply cost26; ♦ lacking flexibility and fluctuation in water price setting, and in provision of, the system of

rewards and penalties; ♦ in many parts of China, as in the Northern China Plain, the water extraction, largely exceed

the sustainable level of supply and the institutional response, for addressing the water scar-city concerns is still largely supplied oriented; and

• finally, the efficiency of water use still is very low. The effective utilization index (EUI)27 is

less than 50 per cent nation wide. [Source: FAO/WAICENT web page: www.fao.org/waicent/china; Qian and Xu, 1994; Saleth and Dinar, 1999].

26 Chinese Water Law introduced in 1985 stipulates many rules and regulations regarding the irrigation

water pricing. First, all water users need to pay water charges and the water charge is calculated based on the quantity of water supplied, the beneficial area, or a mixture of basic water charge plus a metered water charge. In the case of droughts or high water scarcity, a rational water allocation system is prac-ticed and dissuasive charges are applied to extra volumes of water. On average, water charges for irriga-tion varied between 150 and 300 yuan/ha (US$17.96 and 35.92/ha) in 1995. The average cost for sprin-kler irrigation development was 6 000 yuan/ha (US$720/ha), and that for micro-irrigation was 18 000 yuan/ha (US$2 200/ha) in 1995 (FAO/WAICENT).

27 EUI is defined as the ratio of water technically required for a crop divided by the amount actually used

(FAO/WAICENT).

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Example 5.0: Economic incentive measures in India: The next case of policy failure In India, the Government adopted a National Water Policy in 1987, which puts emphasis on the need for river basin planning, and requires to develop water resources development plans by each states. However, no central legislation or legal instrument exists governing the formation of WUA and "full cost pricing" of irrigation water with exception of only one state Andhra Pradesh, which has passed legislation exclusively for farmer participation in managing irrigation systems. Water pricing system is still based on per unit of land area irrigated with some differentiation by seasons and crops. The water rates are higher for storage systems than for flow diversion schemes. The volumetric pricing system is practiced for lift irrigation water supplies with higher price in the case of government operated lifts, compared to the co-operative lifts. In some States, such as Gujarat and Tamil Nadu, informal water market exist for trading ground water to rainfed areas. However, in other states or regions, the charges are low and the overall water use effi-ciency in canal irrigation systems is also estimated very low in the range of 38 to 40 percent. The cost of water subsidy in India is still very high ranging from US $450-560 per ha in the case of sprinkler system to US$750 per ha in the case of drip irrigation systems. [Source: Nagraj, 1999; Dinar and Subramanyam, 1998; Saleth and Dinar, 1999]

ROLE AND USE OF ECONOMIC INCENTIVES IN ......2Ariel Dinar, Lead Economist, Rural Development...

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