Economic and Financial Instruments for IWRM Water valuation methods and economic instruments
Goal and objective of the session
To know about main water valuation methods for supporting the use of economic instruments.
To be able to evaluate the pros and cons of using specific water valuation methods in different water situations .
A cost benefit-analysis framework
Supply and demand
Main approach: full cost recovery
Description of main water valuation methods
Economic instruments are important for water management, especially when there are notorious supply-demand imbalances and misallocations.
As markets are seldom available for solving these problems, water authorities will decide about levels and features of water tariffs in order to influence behaviour and allocations.
In deciding about this, information is required regarding how users value different water services.
Multi-sector use and water valuation
Importance of cost-benefit analysis
To reallocate water among alternative uses or type of users;
To expand water infrastructure;
To improve the quality of water;
To expand the water service to include sanitation and wastewater treatment;
To include water management actions at the basin level (very important for IWRM);
These decisions will generate potential benefits but also costs for water stakeholders The main objective of cost-benefit analysis is to appropriately measure and attribute these benefits and costs.
Water valuation and economic instruments
Even if a market is not in place for water service, demand and WTP exist and reflect how much are the water services valued by users.
Costs are the value of the opportunities or resources foregone in the process of generating the benefits.
Challenge for valuation methods is how to measure benefits of water services given situations in which there are not observable markets or prices for those.
Equally important are correct estimation of costs and appropriate levels of tariffs to be charged directly to main beneficiaries.
Demand function and residential use (1)
Close to be a private good but under monopolistic provision
Demand can be estimated looking at consumer behaviour and tariff changes:
Qw = Qw(Pw,Pa,P;Y;Z)
Qw: the individual’s level of consumption of water in a specified time period;
Pw: price of water;
Pa: price of an alternative water source;
P : average price index representing all other goods and services;
Y : consumer’s income, and
Z : vector representing other factors, such as climate and consumer preferences.”
Demand is estimated using econometric methods applied to data from water use, tariffs and local and users´ attributes.
When this type of data is not available (or for new projects), hedonic price methods and contingent valuation methods are also used
Demand function and residential use (2)
Hedonic price estimations
Although there is no market for a water service to be evaluated, there are other markets in which these benefits are embedded (for instance, real property transactions near an water aesthetic place will somewhat incorporate these benefits, although bundled with other attributes of the property).
This method is based on the assumption that the price of a marketed good is a function of its different attributes, and an implicit price exist for each of these.
Travel cost methods
Most amenity and recreational water sites charge a fixed entrance fee to users, there is no variation according to demand for those services. Estimation of demand is problematic.
Travel cost incurred by visitors is an indirect way to estimate this demand since there is variation among visitors in travel expenses.
When this is possible (using special surveys, for instance) a demand can be inferred giving a measure of total benefits generated by the site.
Contingent valuation methods
These methods have become very popular to estimating the values of water related goods for which there are no markets or when the water service is to be created.
Since consumers do not have a clear idea about the nature of the service, the researcher has to explain it very clearly and ask questions regarding the willingness to pay for these services.
Valuation of water as intermediate good
Often water is not directly consumed but enters a productive process like agriculture, industry or hydroelectric power generation.
Producers will demand an input according to its marginal productivity.
When there is no market for the input, like for water, special methods of valuation are needed:
Hedonic price method (when a surrogate market can give information on MVP of water);
Residual imputation approach and
Alternative cost approach.
Residual method for water valuation
Is the most-frequently used, particularly to irrigation water.
Uses a production function approach.
A total production function is estimated and the marginal contribution of all relevant inputs (including water) are estimated with production data and prices for the non-water inputs.
If these prices correctly reflect their scarcity (well working markets), the remainder of total value is considered the contribution of water to total value
Think about it
How useful are water valuation methods for designing water pricing policies?
Do you have in your countries human and financial resources to make water valuation studies? Which studies seem more useful for policy applications?
What is needed to value water at the source from water values at each sectoral use?
Chapters 1-3 have introduced IWRM and the need for economic and financial instruments. For them to be effective, contributing to sustainability, and improved access to basic services, they need to be applied.
Their application will be examined in the next two chapters.