E N V I R O N M E N T t3 ~D E P A R T M E N T P A P E R S PAPER NO. 62 TOWARD ENVIRONMENTALLY AND SOCIALLY SUSTAINABLE DEVELOPMENT ENVIRONMENTAL ECONOMICS SERIES Managing Water as an Economic Resource: Reflections on the Chilean Experience John Briscoe Pablo Anguita Salas Humberto Pefia T. April 1998 Environmentally and Socially Sustainable FWLmE r Q DT orld Bank .'"-.'ESSD' .rTI Managing Water as an Economic Resource: Reflections on the Chilean Experience John Briscoe, Senior Water Advisor, The World Bank Pablo Anguita Salas, National Director of Irrigation, Government of Chile Humberto Pefia T., Director General of Water, Government of Chile April 1998 Papers in this series are not formal publications of the World Bank. They are circulated to encourage thought and discussion. The use and citation of this paper should take this into account. The views expressed are those of the authors and should not be attributed to the World Bank. Copies are available from the Environment Anchor, The World Bank, Room MC-5-105. Contents Background 1 Water as an Economic Good-the Chilean Approach 3 Water Markets from a Conceptual Perspective 3 Water Markets in Practice in Chile 3 The Water Resources Management Challenges in Chile 6 Challenges for the Government of Chile 9 Current responses by the Government of Chile 10 Conclusions for the World Bank 11 FiGURES 1. WRM Policy Paper concepts 1 2. Map of Chile showing climatic zones and Elqui, Limari, and Maule Basins 4 3. Indicative and partial characterization of the complexity of water resource management challenges in Limari and Maule Basins 7 Environmental Economics Series iii Background In 1992 the World Bank prepared a new shows that many countries are dealing, in a Policy Paper on Water Resources variety of ways, with (a) considering water as Management (WRM). The WRM Policy a unitary resource, which must be dealt with Paper comprises three core, interrelated in a comprehensive way and (b) providing for concepts, as indicated in figure 1 below: broader participation by stakeholders in Figure 1. WRM Policy Paper Concepts t W~omprehens veA management of water arrangements, with greater Water as an V articipation of stakeholders, the * economic good There is broad consensus internationally as water resource management. There are, reflected in the resolutions of the however, few countries which have seriously International Conference on Water and the conceptualized what it means to deal with Environment, held in Dublin, Ireland, and in water not only as a natural and social Agenda 21 of the Rio Environment rer but as a nomic and too. Conference, that these three elements are the resource, but as an economic good, too. keys to a well-functioning water sector. Chile's uniqueness lies in the facts (a) that it Accordingly there are many countries which has put "water as an economic good" front are attempting to reorient their water and center-stage and (b) that it has been resource management practices to conform to translating this principle into practice for over this new view. A review of these experiences 15 years. Environmental Economnics Series Managing Water as an Economic Resource: Reflections on the Chilean Experience Because of the importance of the Chilean management system, the interested reader experience, in November of 1995 the is referred to: Government of Chile hosted a study tour of Humberto Pefia T "Water markets in Chile: about 30 professionals, most from the World What they are, how they have worked and Bank, some from developing countries. This what needs to be done to strengthen them?" report draws together the observations of one Paper presented at the Fourth Annual World Bank participant in that study tour, World Bank Conference on Environmentally and the observations of two Chilean Sustainable Development, Washington DC, professionals who hold leadership positions Sept. 1996. in the Chilean water sector.' Endnote Renato Gazmuri Schleyer and Mark> W. Rosegrant "Chilean Water Policy: The role of water rights, institutions and markets", 1. For more detailed assessments of the Water Resources Development, Vol 12, No functioning of the Chilean water resources 1, pp 3348, 1996. 2 Environment Department Papers Water as an Economic Good- the Chilean Approach Since the 1970s Chile has followed, with sales between willing buyers and willing remarkable success, an export-oriented, sellers. market-based approach to economic development. There are several Water Markets from a Conceptual consequences which are of direct relevance in Perspective attempting to understand the water economy From a conceptual perspective, tradeable of Chile. First, there is a broad consensus water rights are a brilliant solution to a across most of the political spectrum in Chile universal problem with the economic on the fundamentals of economic policy- management of water. The problem is export orientation, trade liberalization, the simple. "Common sense pricing" suggests central role of the private sector, and that users are charged a tariff which covers maximum use of markets as a resource the financial (investment and operating) costs allocation mechanism. Second, the ideas of a of storing and delivering the water to the liberal market economy are translated with user. (It is this which is done by users' consistency and rigor down into the associations who operate water systems at operation of each and every sector of the various levels in Chile and which is now economy. being proposed-see below-for costs incurred at the basin level, too). The problem The core of the Chilean approach to treating arises because these financial costs are much water as an economic good, as enshrined in lower (often an order of magnitude lower) the Water Code of 1981, is: than the "opportunity cost" (which reflects the value of the best alternative use of the * The acknowledgment that water is not a water). The existence of a water market factor of production only for agriculture, means, however, that behavior is not driven but for other sectors too, and must thus by the financial cost of the water but rather by be transferable like any other economic the opportunity cost-if the user values the input water less than it is valued by the market, then the user will be induced to sell the * The acknowledgment of the water. This is the genius of the water market inappropriateness of linking a mobile, approach-it ensures that the user will in fact flow resource (water) to an immobile, face the appropriate economic incentives, but stock resource (land) de-links these incentives from the tariff (which is set on "common-sense" grounds). * The consequent importance of separation Water Markets in Practice in Chile of water rights from those of land * Dealing with water rights as any other (a) In the Limari and Elqui Basins in the property right, allowing for leases and semi-desert climatic zone Environmental Economics Series 3 Managing Water as an Economic Resource: Reflections on the Chilean Experience Figure 2. Map of Chile showing climatic zones and Elqui, Limari, and Maule Basins A3ricl-url Zone IRregion M... Annuol M .A.o Ann-1l Proutin, Capitol$ ICrs _Ln ImrigrHted ooses I . . 1_ and river valleys Desert . . 1kIQUIQUE X tt ~~~~18.3- 277 W , SJ -lANTOFAGASTA Irn'goled river _ 1 ..p0 itinerant sheep ar;dAn COAP_*_ L. 14.4' 100- X r g [~~~~A SERENA Frvits, vegetaibles, McIIIr 1o 30 6 gnf1p Sef wh t, _39 - 167; maiz:, ilk,'P IO ra3ec9 corley, onsh epeoep, rMC sugor, pulses, . ~~~~~~~~~~~~~~~~1A 131 4~~~~sep forestry, TeprtmntaPter Water as an Economnic Good-the Chilean Approach The Limari and Elqui are adjacent basins in a with as "rights".) The implicit assumption is very dry area with a well-regulated river. that "non-consumptive rights" will generally The Limari Basin is the area where water not interfere with prior consumptive rights- markets are generally considered to function in fact the Water Code requires that the best in Chile. The performance of the water exercise of non-consumptive rights not market in this area is indeed impressive. damage existing consumptive rights. There is a broad range of instruments available to buyers and sellers (ranging from In practice the interactions between non- short-term sales of specific volumes of water, consumptive hydropower rights and to annual leases, to permanent sales of rights). The market behaves exactly as one consumptive (maily irrigatlon) rights turn would wish: within a particular area water is out to be complex. The Maule Basin traded from lower-value uses to higher-value ilterates the inmseveral oftes uses; prices are responsive to both temporary interactions. First, in several cases (seasonal) scarcity as well as longer-term hydropower plants return water to the river scarcity; trading is quite active. 30 or more kilometers downstream of the abstraction point. Given the density of direct The functioning of the markets (and the irrigation offtakes from the river, this means users' associations at various levels) in this that there are numerous irrigators whose area are impressive. But there are some services are affected by these "non- problems-some emerging difficulties in consumptive uses" (almost 100,000 hectares matching the location of sellers (generally in are so affected by just one power station in the lower reaches of the Limari Basin) with Maule). The hydropower companies have buyers (increasingly wanting the water in the made efforts (as is required by law) to upper reaches): and the fact that urban water compensate irrigators by constructing supplies are only partially integrated into the additional distribution canals so that prior water rights system. rights are respected. Inevitably, however, (b) In the Maule Basin in the Mediterranean there are some farmers (many, in the case of Climatic Zone Maule) who perceive (accurately in at least some cases) their services to be negatively The Maule Basin is a large basin in the affected as a result. relatively well-watered Mediterranean climatic zone. Water in the basin was A second complication arises from the fact historically used primarily for irrigation, and, that, although hydropower plants do not more recently, for hydropower, with flows consume water, they affect the hydrographs regulated by a reservoir in the upper reaches in the downstream areas in a number of of the catchment. In the early 1980s important ways. One result of the changed .consumptive rights" were distributed free of flore ett irrigation caalaen charge (as elsewhere in Chile) to existing irrigators. The Chilean Water Code of 1981 often not of the appropriate design and distinguishes between "consumptive" and greater use has to be made of adjustable "non-consumptive" rights, with the latter gates. A second impact is that, as a result of primarily dealing with hydropower. (Other lower silt loads in the water, there are greater non-consumptive in-stream uses, such as problems with controlling algae in the canals. navigation, conservation of aquatic Both of these factors mean that farmers have ecosystems, dilution of pollution and control to incur additional costs in managing the of saline intrusion in estuaries are not dealt irrigation systems. Enviromnental Economics Series 5 Managing Water as an Economic Resource: Reflections on the Chilean Experience The changed discharge patterns also have First, it is obvious that the absence of a r iver important effects on the value of pre-existing basin management institution is a water rights. Before the construction of the fundamental factor giving rise to the problem hydropower complex in the Maule Basin, in the first place, and is a fundamental factor farmers had rights to a constant flow of water underlying the ongoing tension. This is during the year (regulated by the pre-existing evident in several ways: large reservoir). The license for the power stations stipulated a non-uniform pattern of * There are information asymmetries and releases, related to the monthly distribution gaps-there is a serious lack of coherent, of agricultural demand. While the power agreed-upon information on basic companies appear to respect these hydrological facts, and on facts about stipulations, the farmers are seriously operating procedures. dissatisfied, for several reasons. First, the farmers' rights have essentially been * There is no "honest broker" institution truncated, because the rights no longer responsible for specifying trade-offs and correspond to a uniform flow during the year. for finding creative solutions to problems. This effectively means that farmers can no longer sell their rights to users (such as towns) which are interested only in * There is no low-financial and low- purchasing uniform flows which can be transactions cost arbitration procedure. supplied with high assurance. Second, it is not sufficient for the power plants to simply Second, it is equally evident that the juclicial release the agreed-upon quota on a monthly process-water conflicts are referred to the basis. The loss of control of the hydraulics of normal court system in Chile for resolving the system means major difficulties for the conflicts is unsatisfactory from several users' associations in operating a demand- perspectives. The judicial processes take based irrigation system, with serious impacts years to come to conclusion, and are costly. on the complexity of managing the system, Equally important is the fact that there is no on costs, and on the quality of irrigation specialized arbiter of water disputes (such as service. Third, there was inadequate the State Engineer in New Mexico), with the consultation when the release regime for the result being that similar cases are sometimes hydropower plants was stipulated, with the resolved in radically different ways. This consequence that the farmers do not regard means that outcomes of cases are the agreements as legitimate. Fourth and unpredictable and inconsistent, with all finally, there is an "organizationalparties in the basin facing hih transactions asymmetry" and associated communication prtis in sth asianfci gtainti nsu challenges between an industrial-type costs and substantial uncertainties as a result. organization (the power company) and a much more loosely-knit farmer's cooperative, There are two overarching reasons for the low on the other. level of activity in the water market in Maule, namely the relative abundance of water in the Although these are not trivial problems to region, and the high transactions costs arising resolve, the level of tension is substantially from both hydraulic rigidities and higher than necessary given the underlying institutional shortcomings. But it is also nature of the problems. There are two apparent that uncertainty regarding property primary reasons for this unnecessarily-high rights in Maule is a contributing factor to the level of conflict. low level of market activity in the area. 6 Environment Department Papers Water as an Economic Good-the Chilean Approach Figure 3. Indicative and partial characterization of the complexity of water resource management challenges in Limari and Maule basins Legend: Limari Basin Maule Basin - COMPLEXITY OF MANAGEMENT Simple ' 0 Complex SECTORAL SCALE irigation only multi-sectoral HYDROGEOGRAPHIC SCALE small command area inter-basin transfer HYDROGEOLOGIC SCALE surface water only conjunctive use of surface and groundwater QUALITY COMPLEXITY quantity issues quality as important dominate as quantity ETC. The Water Resources Management presence of major hydropower generating Challenges in Chile stations in the Maule Basin. It is instructive to attempt a tentative and The water resource management partial characterization of the complexity of problems in many basins in other the water resource management issues in the countries will be much more complex Limarf and Maule Basins and to use this to than those in these two Chilean basins. assess the future challenges of managing the water resources of Chile. With regard to the future of river basin management in Chile, it is obvious to all that Figure 3 suggests that: complexity is increasing sharply in many basins. Particularly relevant are: * The water resource management issues are somewhat more complex in Maule * The rising demands of all traditional than Limarf principally because of the water-using sectors Environmental Economics Series 7 Managing Water as an Econornic Resource: Reflections on the Chilean Experience * The emerging importance of the the rapidly-growing commercial forestry environment as a non-traditional sector areas, where extensive eucalyptus and with important water demands pine plantations are certain to dramatically affect surface water flows) * The emergence of sharper conflicts between different sectors * The need to consider water quality, in addition to the traditional concerns with * The consideration of inter-basin transfers water quantity * The need to use surface and groundwater * The emergence of new or newly-recognized conjunctively in many basins (with the "stakeholders" (including environmental issue likely to be particularly important in groups and indigenous people). 8 Environment Department Papers Challenges for the Government of Chile The development of a system of tradable Water Act-water rights will lapse if the water rights and associated water markets is rights are not exercised within a a great achievement and is universally agreed prescribed time period, and water rights to be a bedrock on which to refine Chilean will be taxed. water management practices. There remain, however, significant resource management * It is essential to improve the performance problems, which the Government of Chile of the administrative and judicial system recognizes and has started addressing. These with respect to water rights and water include: disputes-at present the system is too slow, too costly and too unpredictable. * As scarcity becomes more widespread, it Experience in the Western United States will be important to regularize and shows that transactions costs are much formalize the quite large number of lower (and markets function much more traditional water rights which are not yet effectively) when these disputes are formal (but are honored in the current managed through administrative system of management). mechanisms (such as the State Engineer, as in New Mexico) than through the • Although environmental impact courts (as in the case of Colorado, for assessments have been required since instance). 1991, critical environmental concerns (such as minimal ecological flows, and * The Government of Chile is now in the water reserved for wetlands) have (with a process of complementing the existing few important exceptions) not been framework for water markets with "water adequately addressed in many water market-friendly" river basin management projects. agencies. From the experience in other countries, such river basin agencies: * Greater attention will have to be given to the economic management of a Should be financing agencies, with groundwater and to the integrated the power to raise revenues from management of surface and groundwater users and polluters resources. a Should involve all stakeholders in the * Speculative purchases of water rights formulation of basin policies (especially by the power companies) constitute an important social and a Should not usurp the powers of lower- economic problem which are being level institutions in the basin (such as addressed a series of amendments to the water users' associations and Environmental Economics Series 9 Managing Water as an Economic Resource: Reflections on the Chilean Experience municipalities) but rather see their role including a "non-use patent", which would as providing a transparent, predictable , charge those (in practice mostly the and efficient framework in which lower- hydropower companies) who hold but do rLot level users can act more effectively. use water rights. Current responses by the Government Since the early 1990s, the DGA focussed on of Chile developing an improved river basin management approach, using the critical Bio- Management of water resources in Chile is Bfo river basin as a model. The main the primary responsibility of the Directorates objective was to devise a new strategy in of Water (DGA), Irrigation (DR) and Planning which all stakeholders and existing (DP) of the Ministry of Public Works. These institutions could work together coordinating agencies define the water management public and private actions. In 1995 an policies, assign water rights, perform "administrative Corporation", broadly hydrological studies and monitoring, and similar to a French River Basin Financing construct the major irrigation infrastructure. Agency, was started. Initially, this is a state- Given the issues described above, the financed Technical Office, but within five Government is currently focussing its years it will develop into a Corporation, attention on a couple of critical issues. staffed by about 40 technical personnel. The goal is to have 60% of the costs of basin The Directorate of Planning (DP) has carried management paid by charges assessed on out a detailed study on water markets in 10 both those who abstract and those who Chilean basins, with special emphasis on pollute the water, and about 40% by regional three-Copiap6, Limari and Maipo. The governmental funds (which would primarily major conclusions of the study were: that it be derived from the proposed charges on was necessary to strengthen water user's those who hold but do not use water rights). organizations; that the transparency of the markets needed to be improved by providing The Irrigation Directorate (DR) is imple- both buyers and sellers with better menting a complementary nation-wide information; that the environmental program focussing on improving the func- framework needed to be developed, with tioning of the water users' associations at both particular emphasis on polluter charges; and the irrigation district and river basin level, and that it was necessary to implement a charging in developing effective mechanisms for system for water uses and water rights, implementing both user and polluter fees. 10 Environment Department Papers Conclusions for the World Bank The issue of water markets in general and in this respect the conditions in many other Chile in particular have been the subject of countries are more favorable than in heated debate within the World Bank. At one Chile, where most rivers are short and extreme ("the right") have been some Bank relatively unregulated. staff who have argued that water markets are a panacea; at the other extreme ("the left") * An essential requirement for functioning have been staff who have argued that water water markets is that transactions costs markets have failed in Chile and will fail are low, and that water law is interpreted elsewhere. Over the course of the Chilean consistently and predictably. study tour, the team came to the clear and unanimous judgment that both of these * Although the water markets in Chile were extreme positions were wrong. The team developed under the non-democratic concluded that: political circumstances prevailing in the late 1970s and early 1980s, the markets are - Countries following the liberal economic now broadly popular. development model must ensure that water (as a key factor of production) is * Externalities and market imperfections allocated to highest value users and used are pervasive, and will become more efficiently. This requires movement away important in coming decades in Chile. To from command-and-control approaches deal with these market imperfections, to resource management and movement water markets depend on and need to be towards the use of market-friendly supplemented by effective dispute instruments. resolution capacity, and by effective basin-level water resources management. * Water markets are an excellent solution to a limited but very important and * The DGA and DR have clearly identified widespread problem (primarily the better both the strengths and weaknesses of "the use of water in irrigated agriculture and Chilean model" and are taking the associated voluntary release of some appropriate and innovative measures to water to higher-value urban and build on the considerable successes they industrial users). have achieved to date. * Water markets function best when rivers are well regulated (hydrologically). 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