The Pricing of Irrigation Water Conceptual Issues

To provide answers to the foregoing questions, it is useful to begin with a review of the motives for raising water prices and the logic of each institutional arrangement with respect to prices. The point of reference is that, for irrigation water, price does not play the normal role of equilibrating supply and demand, except in the case of markets for water rights, which so far have had limited applicability. Accordingly, in most cases, the justification for the level of this price must be different than that of balancing supply and demand.

Within a framework of overall policy objectives such as the discussion in Chapter 2 of this book, there are five fundamental reasons, or sub-sectoral objectives, for setting the price of irrigation water at an appropriate (which usually means higher) level. The first three reflect societal concerns for the utilization of a scarce resource and the last two, fiscal concerns. They are as follows:

(i) To stimulate the conservation of water.

(ii) To encourage the allocation of water to the most water-efficient crops, i.e. to its highest-value agricultural uses, or to non-agricultural uses if water is more productive there in net terms, after allowing for inter-sectoral conveyance costs, provided that the infrastructure exists for delivery of the water to new users. This kind of allocation would maximize the economic growth benefits of a scarce resource, although it should be pointed out that often the intersectoral infrastructure condition is not satisfied in irrigated areas in developing countries.

84. M. W. Rosegrant, R. Gazmuri S. and S. N. Yadav, 1995, p. 208.

(iii) To minimize the environmental problems attendant upon irrigation, especially those arising from excessive use of water.

(iv) To generate enough revenues to cover operating and maintenance costs of irrigation systems so that, among other things, it would not be necessary to invest in expensive rehabilitation projects.

(v) To recover the original investment costs of each system, in addition to providing revenues for O & M costs.

Daniel Bromley has argued that promoting economic efficiency should not be the relevant goal for irrigation pricing policy, but rather:

the purpose of the irrigation pricing regime should be to ensure that water allocation within an irrigation system (or community of irrigators) is optimal with respect to the efficient operation of the system as a domain of shared access to a scarce resource. . . . water pricing must be seen as part of a regime in which farmers are induced to contribute to a public good - improved water management - that benefits each of them. The principle of reciprocity requires that all individuals contribute to the public good exactly that amount that they would most prefer every member of the group to make.85

In practice, Bromley's prescription would lead to price levels that cover O & M costs but would not rise to the level of opportunity costs (efficiency prices) of water.

In some circumstances, there may be one argument for not raising the price of irrigation water, or for limiting its increases:

(vi) If irrigators represent poor rural households, a higher price of water may cause them real economic hardship. This is the equity concern.

Whatever the merits of this last argument, it is evident that raising the price of irrigation cannot serve the equity goal of reducing rural poverty in the short run. It may be argued that improved cost recovery would enable the government budget to build more irrigation projects in the future, although it is doubtful whether most farmers would believe that such a linkage is firm. A more persuasive argument is that higher water rates would lead to a more efficient allocation of that resource, creating more employment and higher incomes. Nevertheless, the basic case for raising irrigation fees derives from the efficiency objective and the policy principles of fiscal and environmental sustainability (see Chapter 2). Since irrigation systems are not sustainable without cost recovery, there is a persuasive argument that irrigation fees are not an appropriate policy instrument for addressing the needs of the rural poor and, as argued in other chapters of this book, development of better research and extension and rural financial systems are apt instruments for addressing rural poverty.

The first three objectives above are associated with pricing policy for demand management, while the last two refer to pricing policy for cost recovery. If there is to be an irrigation subsidy for purposes of poverty alleviation, it pertains to the latter category of policy, i.e. it is calculated as part of public budgetary policy and constitutes a deliberate decision not to recover all costs, either of investment or of O & M, or both, and to provide public funds in place of user contributions, at least to a degree. However, obviously a reduction of irrigation charges for this purpose would have collateral, negative effects on the degree of achievement of the other three objectives. In any event, it would be difficult to justify reducing them below a level which is adequate for funding operation and maintenance.

Care must be exercised in adducing other 'social goals', such as higher levels of agricultural production and lower urban food prices, as justifications for low irrigation rates, with the possible

85. Daniel W. Bromley, 'Property Regimes and Pricing Regimes in Water Resource Management', in Ariel Dinar (Ed.), The Political Economy of Water Pricing Reforms, Oxford University Press, New York, 2000, pp. 37 and 47.

exceptions of extreme poverty and important gender concerns. However, irrigated farms almost always generate incomes above those of the poorest rural strata. Promoting the goal of higher agricultural production through subsidized irrigation would appear to represent a move in the direction of greater efficiency, but the distortions caused by low irrigation prices cause inefficiencies that may well cancel the putative gains in production. Recall the experience of Chile mentioned above in which higher irrigation prices generated changes in the direction of higher-value crops. Similarly, concerns about the welfare of urban populations are most appropriately addressed through targeted subsidies for those groups, and not through low agricultural prices (see the discussion of policy objectives in Chapter 2 and the discussion of subsidies in Chapter 3).

Objective (ii) is in essence the efficiency objective as interpreted for the irrigation sub-sector. For the latter, pursuing that objective via pricing policy requires that the price of irrigation water reflects the (marginal) productivity of water in its most productive alternative use - its opportunity cost. Sampath (1992, p. 972) correctly points out that, according to the general theory of second-best, the absence of competition in supplying irrigation water to farmers means that setting the water price equal to its marginal cost (of supply) does not necessarily guarantee the most efficient economic outcome. Nonetheless, the economic gains from setting the water price at its opportunity cost can be very real and significant, as Robert Hearne and William Easter have concluded in their analysis of the experience of four watersheds in Chile.86

The objectives pursued in practice vary with the institutional character of irrigation prices. When those prices are established by governmental agencies, the primary reasons usually are fiscal, that is, objectives (iv) and (v) above. An enlightened policy may be motivated also by objectives (ii) and (iii) and, especially if water is scarce, objective (i). Farmers, whose primary concern is their income level, are not likely to concur in the importance of all these objectives. An increase in administered irrigation prices 'is correctly perceived by rights holders as expropriation of those rights, which would create capital losses in established farms'.87 Frequently, however, they can be persuaded that recovering O & M costs (objective (iv)) is worthwhile, for the sake of keeping the system viable. Hence, dialogs between governments and farmers tend to center on the O & M factor.

Typically, the level of irrigation fees required to recover O & M costs is well below the value of water in alternative uses. Most research has found that the average and marginal water productivity are greater than the average and marginal costs of making water available.88 Furthermore, fees set at a level to recover costs still are usually well below the opportunity cost of water.89 For the case of the irrigated districts of Mexico, which cover about 2.8 million hectares, Ronald Cummings and Vahram Nercissiantz found that although the Mexican National Water Commission has a legal mandate to collect O & M costs for systems, water prices to irrigators are as low as 4% of the scarcity value of water.90 Therefore, experience suggests that a dialog that is developed around the objective of financing O & M activities is not likely

86. Robert R. Hearne and K. William Easter, Water Allocation and Water Markets: An Analysis of Gains from Trade in Chile, World Bank Technical Paper No. 315, The World Bank, Washington, DC, USA, 1995, in particular, pp. 38-41.

87. M. W. Rosegrant and H. P. Binswanger, 'Markets in tradable rights: potential for efficiency gains in developing country water resource allocation', World Development, 22(11), November 1994, p. 1619.

88. G. F. Rhodes, Jr and R. K. Sampath, 'Efficiency, equity and cost recovery implications of water pricing and allocation schemes in developing countries', Canadian Journal of Agricultural Economics, 36(1), March 1988, p. 116.

90. R. G. Cummings and V. Nercissiantz, 'The use of water pricing as a means for enhancing water use efficiency in irrigation: case studies in Mexico and the United States', Natural Resources Journal, 32, Fall 1993, pp. 739 and 745.

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