Pricing Water for Conservation

Address to Earthwatch's Shearwater Conference,
30 June 2000

INTRODUCTION

One view of water regulations and ownership is that they follow a cyclical pattern oscillating between common and private ownership.  Some substance to this view can be offered in these days of privatisation and attempts to loosen regulatory controls by the knowledge that one of the earliest large scale irrigation programs was constructed by one of the earliest sophisticated governments.  This was the Assyrian system of 3000 years ago interconnecting the Tigris and the Euphrates, and named Hammurabi the Abundance of the People, after the founding monarch.

The highly efficient irrigation system made possible by government control, eventually decayed into disuse once the power of government weakened.  Modern water and irrigation systems, needed wherever water is scarce, have likewise depended on some central authority

USES OF WATER

Water usage can be classified into several categories:

• Drinking
• Industrial production
• irrigation
• recreation
• power
• environmental

This list is offered to remind us that environmental uses are only one set of such uses for water.  Like all other uses, environmental uses assume higher worths the greater the value we place on environmental assets.  And that value tends to increase as these assets become more scarce.  It is also important to recognise that environmental values comprise several forms:

• those that impinge upon the ability of others to produce goods and services that make use of those assets -- in other words, destructive use;
• those producing goods and services that make use of the assets but do not change them or use them in any destructive way;
• and those that involve no use except that which goes with their existence.

Water conservation contains all three elements.

ENVIRONMENTAL GOALS

We need to ensure that water is allocated appropriately to these sometimes conflicting uses.  These are the issues before us.

To set the stage, let me give vent to some cynicism.  Many of us will have read statements like "As a nation/state, we are presently using 70%/30% etc. of our available water resources".

Such statements imply that usage is a one and only event.  In fact water usage has several dimensions, most of which can occur several times with the same molecule.  Thus it is estimated that the average Londoner drinks water that has been used for half a dozen purposes prior to it meeting its final use value in the human gut.

Similarly, we have all seen the ABC programs graphically illustrating the effect of salinisation on the land.  Such alarmist pictures have been given a new lease of life as a result of the rural whinge we have experienced over recent years and the NFF/ACF alliance designed to screw money out of the taxpayer for rural reconstruction.

Yet, If we look at agricultural output, we find more encouraging signs.  In the past forty years, Australia's farm production has increased by 130 per cent.  Performance in other countries has been comparable.  Table 1 offers some quantification of this in Australia.

Table 1:  Average % Increase in Volume of Farm Output

1951-1962	1962-1972	1972-1982	1977/8-1998/9
4.0	3.5	1.0	2.6

Source:  ABARE

Even though many claim we are approaching the limits to increased productivity, and that a downturn is imminent, in recent years, output has continued to increase faster than inputs.  There is frequent concern about sustainability of present productivity trends.  Thus, Bartle in the NFF publication, Reform Autumn 2000 notes that the WA Salinity Plan is estimated to expand to cover 32% of the land area from the present 9% in the coming decades.  The numbers however refer to affected land which in the main remains productive.  Like other parts of Australia, overall, WA land productivity has not shown signs of falling.

These facts suggest scepticism is warranted with regard to the recent report published by the ACF and NFF. ⁽¹⁾  The report calls for annually an additional $3.7 billion of government spending and a total $6.5 billion.

The report claims that, currently, degradation costs at least $2 billion each year, and is increasing at an accelerating rate.  It estimates the investment expenditure it advocates has the potential to generate a 6.5% annual return, for the next 100 years.  The bulk of the benefits are in forestry and the report envisages a 20 fold growth in that industry.  Such an increase is highly improbable, especially since forest cover is already at least half of its level at the time of European settlement.

EXTERNALITIES

Nonetheless, we do have a classical externalities situation.  And this might be enough to frustrate the smooth operations of Adam Smith's evocatively phrased "invisible hand" -- the uncoordinated process under which men, pursuing in the main their individual interests, are able to discover needs for goods and apply their knowledge and capabilities to satisfying these needs by making use of price signals.

Individuals will seek to make intensive use of free inputs whilst economising on inputs for which they have to pay.  Under such circumstances, where the free input has a value, society will not be making the best use of its factor endowments.  Property which is unowned will lead each individual to maximise his own value with little regard to the ongoing value of the resource.  Failure of the individual to take the value for himself will simply mean others will do so.  Baden and Stroup ⁽²⁾ liken the process to five young boys sucking soda from a glass -- the law of capture prevails and no conservation control or temporal allocation of the depletable resource is possible.  If the asset's ownership is vested the owner will attempt to maximise its present value, taking into account future alternative uses.  By ensuring that others are excluded, a landowner can determine whether the property merits conservation or modification;  whether it warrants spending resources to improve its fertility, accessibility, aesthetic qualities etc.

For this reason, Hayek maintained "The aim of the rules of law is merely to prevent, as much as possible, by drawing boundaries, the actions of different individuals from interfering with each other".  Drawing of boundaries and further defining them as the need arises has been a major force in allowing efficient trade to take place on the basis of separate pursuit of the individual's own interest.  Boundary drawing and minimizing communal and especially unowned property allows the assignment of appropriate values to different inputs.

An indispensable key to efficiency is the clear allocation of property rights together with the rule of law and the ability to trade.

Externalities are the most persuasive reason why markets may not provide efficient development.  These are costs or benefits emanating from an uncontracted use of resources or spillovers from transactions where contracting parties make mutually acceptable gains but in the process impose costs (or confer benefits) on others.

ALLOCATING THE USE OF WATER THROUGH PRICING

Pricing comes with property rights to produce the best allocation of resources.  Prices condense all manner of values into a single item.  The system requires three things:

• first that the resource be scarce, and for much of mankind's history water was not scarce, at least in a great many locations and at many times, and would therefor command no price.  But even in relatively primitive places where water was scarce, it was husbanded and charged to ensure its rationing.  Instructive in this respect is the scene from Lawrence of Arabia where Lawrence's guide was killed for drinking from a well owned by the Arab chieftain played by Omar Sharrif.  Although Lawrence saw this as an example of the Arabs being a cruel and barbaric race, firm water rights was the only means they could ensure its conservation and use for the most pressing purposes;
• secondly the right has to be defineable, measureable and hence able to be policed
• third, the water has to be tradeable.  If, like indigenous land rights, the commodity is required to be used by the owners or not used at all, its value is drastically reduced and the signals the market might offer are severely attenuated.

URBAN WATER USE

Where, as in most urban situations, water is based on property values rather than its actual usage, there is too little incentive to frugal usage.  But for urban households, water pricing is really about ensuring an adequate cost recovery for the distribution and waste water disposal systems rather than putting a price on virgin water.

The scarcity value of water itself is not a large component of the final cost to the urban householder -- probably only 10%.  This means that a price that was more cost reflective of the value of the water per se would have little effect on the consumption pattern.  In other words, while there are good reasons to bring a better alignment of costs and prices in urban water use, there would be little conservation of the water itself as a result.

WATER FOR AGRICULTURAL USE

But some 80% of water is used in agricultural areas and here the virgin water/total water cost differential is much closer.  Not only that, but the costs of dams and irrigation channels are rarely fully recouped in the charges to farmers.  And there are considerable numbers of ways that water can be conserved on the farm -- ways that range from drip rather than spray injections to changing crops from water intensive to low water usage varieties.

LOOKING AT SOLUTIONS TO OVER-USE
AND ENVIRONMENTAL DEBITS

APPLICATION TO USE VALUES

Water rights usually have accompanied title to land.  Water in a system that was fully allocated therefore needed to be acquired alongside the land to which it was attached.  Moreover, the quantity and security of supply over the water rights were frequently unclear.

Separating water entitlements from land titles allows much greater flexibility.  Water can be bought to meet particular needs, for example seasonal requirements or as supplements where there are drought conditions.  The price in such circumstances is likely to be high.  Trade takes place however where sellers value the loss or deterioration of their own crop less than the money the buyer is prepared to pay to ensure the survival of his crop.  Permanent trades can also be made so that there is adequate insurance for a long term farming investment.

According to the National Competition Council, in Victorian irrigation areas, between 1-4% of water rights are traded permanently every year, and up to 17% are traded on a temporary basis.  The NCC points out that the same megalitre of water that produces a kilogram of rice may provide five to twenty times the financial return when applied to wine grapes.  These sorts of these sorts of differentials to stimulate more efficient allocation water use is demonstrated once the water itself is vested and tradable.  John Dainton, Chairman of the Goulburn Broken Catchment Management Authority has provided information that over the past 10 years 80 per cent of farms in the region have moved to re-use their water.

Properly pricing water will have beneficial effects by deterring its over-use and consequent washing out of salts from the soil bringing salinity problems.  Not only does the farm itself have incentives to economise on water use but the greater value attached to the water encourages conservation in channels with gains from evaporation.

But if this indirect means of arranging for the externalities of pollution/salinity fails it is difficult to find practical ways of addressing the problem.  In principle it would be possible to measure use of water and run-off from each property and apply forms of tax or tradeable pollution rights to encourage reduced run off or reduced salt contamination.  But effecting such a program is daunting.  Aside from issues of measurement from each property adjoining a river system, there is the issue of properties inland from the one being measured, issues where different properties adjoin the two banks of each river and so on.

Some suggestions for addressing salinity have included taxes on fertilizer, an approach apparently used in Denmark.  Aside from the fact that this is an extremely blunt instrument that takes no account of the degree to which run-off affects different river systems and the diverse degree to which run-off occurs farm-by-farm, there is the vexed issue of farmer lobby power to overcome.

The recent Victorian election brought to a head the bubbling discontent about the once feted diversion of he Snowy.  This brings into relief the issue of valuing water for direct conservation, and for use values due to the alleged benefits the Snowy waters bring through flushing of fishing grounds.

If 17% of the Snowy waters were to be redirects away from the current hydro system this could be interpreted as reducing the capital value of the system by $400 million or more.  Part and parcel with this would be an increase in the prices paid by all customers and a reduction in the security of supply for electricity.  In addition, since all the water is allocated the present irrigator, industrial and urban beneficiaries would seek compensation.  It is doubtful that the new beneficiaries would contemplate paying anything like the sums necessary.

Hence water pricing in that case would need to be a tax.

In other cases, some pricing of water could be put in place for recreational uses, including fishing and boating.  Offering salt bonds for tree planting might also be a fruitful approach.  But it is doubtful that the sums needed to satisfy some environmentalists could be raised by these sorts of means.  Moreover, it would not be appropriate to raise money to combat salinity from boating or (probably) fishing since these outputs of the water are not related to its salinity.

CONCLUDING COMMENTS

Salinity and other water issues have been elevated to considerable importance in Australia.  The issue actually comprises dry land farming in Western Australia and over-use plus salinity through leeching in the Murray system.

Allocating specific individual ownership rights to water and allowing its trade is a well founded means of maximising the use value.  It would also be likely to have the beneficial side effects of reducing salinity and farm based pollutants caused by intensive use.  We should grab such opportunities.  But if the problem is as great as some claim, we need other solutions which might well include market type pricing within a regulated framework of reduced water availability.  But we also may need to live with salt levels that were higher than in previous eras.  Technology, including biotechnology, may provide some solutions in this respect.

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ENDNOTES

1. National Investment in Rural Landscapes, NFF and ACF, May 2000.

2. Baden R and Stroup J "Property Rights and Natural Resource Management" Literature of Liberty Vol II No 4, September-December 1979.