Water policies and strategies in many countries now require the implementation of some form of charging for irrigation services. Most commonly the stated objectives of these policies relate to cost recovery - especially recovery of the ongoing costs of operation and maintenance - and sometimes the need to conserve water. Often, these objectives are qualified by concerns at affordability and access to services for the poor. In the literature, considerable attention is devoted to the theoretical role of economic instruments - pricing and markets - to encourage productive use and optimal allocation.
This chapter summarises the most significant aspects of the objectives of water charging, based on an extensive literature review. The full bibliography is listed at the end of this report. Here, to improve readability, references to points which are widely agreed are omitted but key issues raised by specific authors are referenced.
Clarity of objectives in formulating water charges is essential: some objectives are in direct conflict (high charges to discourage waste will impact heavily on the poorest farmers; sophisticated charging systems based on volumetric measurements are expensive to introduce and operate, increasing bureaucracy). Other objectives are simply unrelated (the charge required to recover O&M is unlikely to be the exact charge necessary to balance supply and demand). Thus a clear definition of what charges are designed to achieve is essential. Box 5 provides an overview of typical water charging objectives referenced in the literature and found in the field. The following sections discuss these in more detail.
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BOX 5 Objectives of irrigation water charging Service delivery - cost and accountability
Demand management, water allocation and pollution control
Social objectives
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Reform of water pricing is most often driven by pressure on government budgets, rising costs of providing services, and government desire to reduce subsidies. For many years, the World Bank has encouraged governments to employ a policy of cost recovery, on the principle that users should cover O&M costs and some of the capital costs.
Acceptance of the rationale for recovering ongoing costs is almost universal (even if implementation is not). Full or partial recovery of investment costs is more controversial because irrigation is often seen as a development expenditure for backward areas, benefiting not only the poor farmers but also society more generally through lower food prices and food security. Where these costs are not recovered, governments pay the difference, thus subsidizing the agriculture sector, a politically sensitive sector, or the infrastructure deteriorates. The International Water Management Institute (IWMI) suggests that levels of subsidy generally declined during the 1990s as governments sought to implement cost recovery programmes (IWMI, 2002). Nonetheless, Dinar, Balakrishnan and Wambia (1998) report that in Punjab, Pakistan, the cost recovery ratio (ratio of income from water pricing to O&M expenditure) was 38 percent in 1994-95, falling to only 26 percent in 1995-96.
Although commentators generally use the term 'cost recovery', Small and Carruthers (1991) distinguish between 'cost recovery' and 'irrigation financing'. Under 'cost recovery', all funds collected go to the government treasury department. In 'irrigation financing', funds are retained within, or returned to, the irrigation agency to meet actual irrigation costs. This distinction is another way of underscoring the need to go beyond a 'simple' calculation of the level of cost to be recovered and making explicit the way in which funds raised are used to benefit the irrigation department or the individual scheme.
The conclusion of most authors is that beneficiaries should pay the full ongoing costs of system operation, maintenance, replacement and upgrading of facilities. Such payments should be clearly designated for use by the operating agency, and accounting procedures should be transparent and encourage efficiency in the operating agency. The extent and form of capital cost recovery (for original investments) is a matter for political decision, but again should be open and transparent. These are the criteria applied in the UK’s water privatisation and in Australia’s Murray Darling basin, confirming their acceptability in developed economic environments in both irrigation and water supply sectors.
Ray (2002) emphasizes that irrigation departments in many countries need to improve the O&M of the main canal system and that “incentives for their staff members to operate efficiently are at least as urgently needed as those for farmers”. According to some writers, water charging can accelerate this process. For Indonesia, Gerards, Tambunan and Harun (1991) state that “the real question for ISF success is whether the Irrigation Service is willing to redefine its role and function... Rather than an attitude of instruction, managers and field personnel of the Irrigation Service have to reassess their role, and have to accept water users as counterparts, almost as co-system managers.”
The same argument has been used in the irrigation sector reforms in Pakistan, where water delivery contracts would include a penalty on the irrigation provider in case of non-performance except in extenuating circumstances (Euroconsult, 1998). A similar discussion has started in Thailand, where the introduction of cost recovery would come with responsibilities for both service provider and customer. Despite these indications of intent, there is no published evidence of water pricing leading to better service delivery to farmers. However, the contrary situation, that poor service delivery leaves farmers unwilling to pay, is frequently cited.
It is argued widely that low water prices in a water-scarce environment send the wrong signal to water users. Farmers do not have any incentive to reduce water use or adopt water-efficient crops. Indeed, they may adopt water-intensive crops, leaving less-favoured farmers with no irrigation service, and over-irrigate their fields. Low pricing leads to overexploitation of scarce water resources - a particularly common problem in groundwater-irrigated areas. Where charges are not linked directly to the volume diverted or consumed, e.g. where charges are fixed per hectare of crop, overall charges may be high, but there is no direct incentive to decrease consumption at the margin.
The logic of pricing for demand management runs as follows: if the primary objective of charging is to recover costs, the issue is whether the unit price implicit in that objective is the same as that required to match demand and supply - in a year of drought as well as a year of plenty. Normally the two prices do not coincide and a considerably higher unit price may be needed to influence demand which will be politically sensitive (not least because cost recovery will now exceed the target level). This can be avoided by a rising block tariff (RBT) where some water is available at a low unit price and additional water at progressively higher prices. In this way, the total charge is kept equal to the target cost recovery level while the marginal unit price is high. However, other complications remain: first the basic issue of management, monitoring and record keeping (which will inevitably be complex and expensive); and second the fact that if the price is wrongly set, the demand may still exceed supply. The solution to this is usually to set a volumetric entitlement or quota, below which charging is volumetric or on a rising block basis (see Box 7). At this point, since appropriate water allocation and demand management are being achieved without reference to prices, the expense and complexity of pursuing pricing in the first place must be questioned. Chapter 4 discusses further the limitations of pricing as a practical tool for demand management in irrigation.
As summarised above, many authors, and indeed experience from real world water resources management, believe that pricing water to manage demand is unworkable in most situations. However, other authors contend that pricing should go further. Thus, Dinar and Subramanian (1997) urge that ‘getting the price right’ to reflect the social value of the resource is important. Ahmad (2000) maintains that “the economic or political dimensions of water scarcity and its low price mean that agriculture should release water to other uses, because the economic value of water is much lower in farming than for domestic or industrial use”. However, Svendsen (2001a) points out that winding down the agriculture sector may not be a viable option for governments where there are no alternative forms of employment for farmers. Economic theory cannot override political reality. In practice, the difference in value between using water for irrigation and using it to meet M&I needs, i.e. the opportunity cost of irrigation, may not be as high as some argue if the multiplier impact of agriculture on the local economy (the off-farm sector) is taken into account. Furthermore, once M&I demand is fully met, the opportunity value of water drops effectively to zero. Overexploited catchments and water-short areas receive considerable attention, but urban demands in many countries can be satisfied using just 20-50 percent of available supply in all but the driest years. In these situations, the permanent transfer of water from agriculture to other sectors would be counterproductive. Legal provisions, ensuring that agriculture would surrender water to urban needs in the occasional dry years under a system of seasonal allocations, would be a better approach than one reliant on the vagaries and complexities of the market. In overexploited catchments, negotiated reallocation may be the best solution.
The views summarised above are in fact contradictory. One group believes that determining financial prices such that demand will equal supply is unmanageable; the other believes that prices should embody not only the influence of financial market forces, but also social, environmental and broader economic considerations.
Tradable water rights go some way to bridging this gap: rights to use water are assigned to individual beneficiaries, ranging from farmers to towns to environmental uses, navigation, etc. Those wishing to buy or sell water do so through a regulated market, which monitors examines third party impacts and controls the transfer of rights to eliminate negative third party effects. This allows security of supply to users, the option to enter the market - and hence generally improve water allocation - and the possibility for the state to enter the market to purchase water for environmental or social purposes. Users thus become aware of the value of the resource they are using.
The World Bank’s Water Resources Sector Strategy gives strong support for the role of water markets as a means of ensuring that users understand the opportunity cost of water to different sectors. However, it should be clear that farmers need to have a legal entitlement to a water right, which they are able to trade. Leaving aside the institutional requirements, water trading requires infrastructure to move measured volumes of water between potentially distant parties.
Maintenance of water quality is usually viewed as a public good and, therefore, it is controlled by regulation. Johansson (2000) remarks that there are two principal difficulties to using water pricing to solve water quality problems: (i) the impacts vary across time and space; and (ii) in non-point source pollution, the source of pollution is typically unknown. Dinar and Letey (1996) explore possible economic incentives to reduce polluted effluents from farms, with examples from California. The direct way is to tax the disposal of polluted drainage water on a volumetric basis. However, this imposes high monitoring costs. Some commentators maintain that raising the irrigation water price induces improved irrigation efficiency and hence reduces drainage flows. However, the link between price and volume diverted is not always apparent or easy to manage. Young and Karkoski (2000) describe a successful scheme of tradable discharge rights in California, the United States of America, to reduce agricultural pollution from non-point sources. All these references to pricing for pollution control focus on the United States of America. In the USA, a number of favourable conditions prevail, including widespread acceptance of the principle that “the polluter pays”, backed by systems of monitoring and evaluation to enforce the principle. Considerable work is needed to achieve similar acceptance in many developing countries.
Investments in surface water resources are made predominantly by public agencies, although investment by beneficiaries or the private sector has been common in some countries. Groundwater development is predominantly a private sector activity. Under public investments, policies of full financial cost recovery imply that beneficiaries are not subsidized. Indeed, the users ought to pay full O&M costs plus replacement costs, if investment is to be sustained. At the same time, and sometimes in conflict with the foregoing, fairness demands that all users get sufficient water to meet their basic (domestic) needs, and that water is allocated to sectors where there are apparently no direct beneficiaries from whom to recover costs (e.g. wetlands and nature reserves). However, political priorities, social policies or vested interests have to be taken into account. Where political pressure is an important determinant of the investment decision, a stated and credible policy of investment cost recovery may be an effective incentive for rational, public decision-making (Svendsen, 2001a).
There are few practical examples of charging used as a benefit tax to help fund other sectors. Saleth (1997) describes one case in Maharashtra, India, where part of the revenue finances primary education and an employment guarantee scheme. However, it is not clear whether the diversion of revenue to other sectors implies recovery of more than full costs. In most countries, collected water fees are insufficient to cover costs of providing water services, let alone subsidize other sectors. Fees usually go to the finance ministry and do not remain on the scheme or in a relevant government ministry.
Johansson (2000) considers equity of water allocation to be “the ‘fairness’ of allocation across economically disparate groups in a society or across time and may not be compatible with efficiency objectives.” Therefore, charging could be used as a benefit tax, to distribute the benefits received by irrigators to others in society or to deprived groups within the system (the poor, tail-end farmers, etc).
Equity, rather than being an explicit objective of water pricing, can in some circumstances be associated with demand management. For example, the use of rising block tariff systems in the water supply sector, which ensure that all users receive a basic service at a low cost, while higher users pay disproportionately more. However, the different characteristics of demand in the irrigation sector make the application of a similar system there less attractive. If the aim were to limit overall water use per land holding, in order to protect the small farmer, then direct control of allocation would be more effective, and less complex, than a rising block tariff system.
Although the available literature identifies a number of theoretical objectives of irrigation water pricing, in practice just two objectives dominate most of the literature and practice: (i) to achieve some level of cost recovery, and (ii) to bring about a reduction in irrigation consumption. The target level of cost recovery, or the magnitude of any reduction in consumption, will vary between schemes and countries.
Some commentators suggest that these two objectives may be combined and addressed through a single approach. However, it is unlikely that the two objectives will coincide precisely, so that additional measures may be required. The following two chapters indicate that it is important to match the charging tool with the objective. Furthermore, while irrigation charging in some form is widely accepted as a means to achieve some level of financial cost recovery, there is debate over the merits of direct charging and other economic tools, such as water markets, to make farmers aware of the opportunity cost of water.
