Box Water Pricing and Water Prices

Economic water pricing does not necessarily require charging the very poorest users the full cost of water. There are likely to be cases where targeted subsidies will be needed to meet the basic water needs of the poor. But it is essential to understand the actual level of subsidy embodied in water prices—that is, the difference between the price paid by the consumer and the true value of the water and its associated delivery costs—and to make transparent policy decisions based on those full costs. It is also absolutely essential to understand who receives those subsidies.

Governments have traditionally subsidized all water use rather than just targeting poorer people.When this happens, those who use the most water receive most of the subsidy. So a poor family who uses, say, 50-100 liters of water each a day for basic needs would receive a subsidy on that volume of water. Meanwhile, a wealthy family might consume 10 or 100 times that amount of water to wash cars, water lawns, and fill swimming pools and would receive 10 or 100 times that amount of subsidy. By subsidizing (undervaluing) all water, all users are effectively encouraged to overuse it. Underpricing water also means that utilities cannot recover their costs, which often leads to poor service and an inability to extend municipal systems and provide water to new users.

"Getting the prices right" does not mean that water should be made unaffordable to the very poor, who consume just a very small share of the water governments deliver. Rather, it means pricing the vast majority of water in a way that encourages productive use and conservation, and carefully structuring and targeting pro-poor subsidies as the exception rather than the rule in water pricing.

Source: See endnote 24.

In some countries cultural practices and beliefs hamper or even forbid the use of water pricing. In some cases it may be uneconomical or infeasible to recover water fees at all. Fortunately, there are numerous market-based tools, as well as legal, regulatory, and participatory ones, that can aid the sustainable management of water. In all cases, good governance and consumer and environmental protection will be crucial for the sustainable management of water.

Water markets, tradable water rights, and water quality credits are increasingly being used to enhance the efficiency of water use and allocation within and across sectors. Water markets are arrangements in which users are granted water rights—sometimes rights of ownership but more often time-bound use rights (called usufruct rights)—which they can sell or trade. In a functioning market, water can thus be "moved" to higher value uses in a transparent transaction that both increases the productivity of water and diminishes tensions among competing users. Appropriate and capable institutions are necessary to ensure transparency, enforcement, and protections for vulnerable groups and ecosystems.

Efforts are being made to explicitly incorporate water into calculations of GDP, to ensure that macroeconomic indicators provide more rational guidance about the impact of water use on economies. These efforts are part of a broader movement toward environmental accounting that began in the late 1980s and was consolidated in 2003 with the System of Environmental and Economic Accounting. The United Nations recently developed a more detailed, specialized System of Environmental-Economic Accounting for Water. There appears to be a good deal of interest in these accounts but little systematic adoption to date, particularly in developing countries.25

The concept of "genuine savings" is another innovation in conceptualizing macro-economic measures of sustainable wealth.


(See also Chapter 2.) Rather than focusing on economic production (like GDP), this approach looks at an economy's creation or depletion of wealth—broadly defined. Genuine savings takes net savings measures for an economy and subtracts the value of resource depletion and environmental degradation (and adds the value of investment in human capital) to arrive at a measure that more fully reflects the changes in the real sources of wealth of an economy. By this measure, many countries are being progressively impoverished by negative genuine savings patterns. Using this to identify losses in wealth can help direct policymakers toward a more sustainable development path, economically and environmentally.26

Trade can also influence water management decisions, both positively and negatively. Global trade in agricultural goods can diminish water stress and take pressure off ecosystems if, for example, water-intensive goods are exported from water-rich areas and imported by water-poor regions, as noted earlier. Recent studies suggest that such trade in virtual water could reduce worldwide water use in agriculture by 6 percent. It must also be kept in mind, however, that packaging, storing, and transporting large volumes of goods also carries its own environmental footprint.27

Health and safety standards, such as water quality standards imposed on traded agricultural products, can be drivers for reform and investment in environmental protection. (On the other hand, in some instances standards can effectively create trade barriers against poor countries.) Diminished barriers to trade in environment-enhancing or water-saving technologies and services can help spread state-of-the-art solutions. The World Trade Organization's current Doha Round of negotiations includes the first multilateral negotiations on trade and environment, with a specific call to diminish barriers to water provision and wastewater treatment services. (See Chapter 14.)

In the absence of effective national regulation frameworks and enforcement, however, global markets can aggravate water stress and ecosystem degradation by creating strong incentives for individuals or corporations to produce inappropriate products (such as water-intensive exports from water-scarce regions) using destructive practices (polluting or overabstracting water sources, for example), which can result in overexploitation of resources, excessive pollution, and the degradation of ecosystem services on which the poor and the environment rely.

Paying for ecosystem services is another market-based tool that seeks to create incentives for maintaining a water resource or paying for watershed services. (See Table 8-2.) These payment mechanisms are differentiated by the degree of government intervention in administration of the schemes and the characteristics of the buyers and sellers. Four types of approaches are distinguished:

• private payment schemes;

• cap-and-trade schemes, under a regulatory cap or floor;

• certification schemes for environmental goods; and

• public payment schemes, including fiscal mechanisms.

In practice, many initiatives are a mix of these approaches, adapted to local needs and context. (See also Chapter 9.)28

Private payment schemes have the lowest level of government intervention. In these, private entities agree among themselves to provide payments or rewards in return for maintenance or restoration of a watershed service. The actual transaction mechanisms in such schemes can take many forms; the most popular ones are transfer payments, land purchases, cost sharing, and the purchase of


Table 8-2. Selected Examples of Payments for Watershed Services


Activities Compensated




Service Buyer

Service Seller

Price Paid (per hectare per year)

Murray Darling Basin, Australia


Salinity control Freshwater supply

Downstream farmers'


Government and upstream landowners


Sarapiqui watershed, Costa Rica

Protecting, sustainably managing, and replanting forests

Hydropower Regulation of flows Sedimentation control

Energia Global (hydropower company) and National Fund for Forest Financing (FONAFIFO)

Private upstream landowners


Costa Rica

Protecting, sustainably managing, and replanting forests

Freshwater supply Wildlife habitat Cultural heritage and identity

National Forest Office and FONAFIFO

Private upstream landowners


United States

Soil conservation

Soil protection Sedimentation control Water quality control Regulation of flow

U.S. Department of Agriculture



State of Paraná, Brazil

Watershed restoration

Freshwater supply Wildlife habitat

State of Paraná

Municipalities and private landowners


Rhine-Meuse Basin, France

Reduced-input farm management

Water quality control Freshwater supply

Perrier Vittel (private bottler of mineral water)

Upstream farmers


Source: See endnote 2S.

development rights to land.

With transfer payments, a service seller receives money from a service buyer in return for the protection or restoration of a watershed service. For example, a hydroelectric power company experiencing increasingly irregular water flows might decide to pay landowners upstream to change their management practices. Here the company assumes that a different management practice will improve water supply.

In a land purchase, a private party may decide to buy land from another private party with the aim of safeguarding the watershed services provided there. Strictly speaking, this is a mechanism for payment for watershed services only if the land is purchased and then leased back to the former owner under a contract stipulating how the land can be used or managed.

In the third type of private payment scheme, beneficiaries of watershed services can agree among themselves to share the costs that must be met by service sellers upstream to maintain or restore watershed services. For example, if conversion of nat

SPECIAL SECTION: PAYING FOR NATURE'S SERVICES Water in a Sustainable Economy ural vegetation upstream is affecting water quality, downstream landowners can agree to share the costs of compensating or rewarding upstream landowners for maintaining or establishing preferred land uses in certain areas.

In cap-and-trade schemes, a cap is established for, say, the release of pollutants or abstraction of groundwater. In the case of pollution, the cap is the aggregate maximum amount of pollution that can be released by participating entities. (See also Chapter 7.) Tradable pollution permits or credits are then allocated by dividing up the allowable overall total among polluters. Industries or companies can sell permits they do not need to other participants who need more than they were allocated. This rewards companies able to cut their pollutant discharge and penalizes those who pollute more heavily, creating an incentive for them to invest in pollution control. Trading increases the economic efficiency of water and environmental management by enabling companies or landholders to buy permits from those able to comply in a cheaper way.

Certification or eco-labeling schemes are a third payment mechanism for watershed goods and services. Transactions occur between private parties, but payment is embedded in the price paid for a traded product, such as certified timber, fish, or organic produce. Payments under this approach can be made to suppliers as, for example, a fixed sum, a fixed sum per hectare, or a price premium on products sold.

Public payment schemes are the most common form of payment scheme for environmental services and have the highest level of involvement by public agencies. Service buyers in these schemes are public authorities such as municipalities or national governments who are typically motivated by the need to provide safe drinking water or regu late river flows. Mechanisms for payment in these schemes include user fees, land purchase, and land easement, which are rights to the specific use of land owned by others.

Environmental taxes are fiscal mechanisms that can be used to ensure that some or all of the external costs of land use are internalized in the decisionmaking process. They create direct price signals for producers and consumers. Taxes can be used as a positive incentive when people are exempted from paying them. Taxes can also be used negatively—to discourage consumption or activities that are detrimental to the environment.

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