The foundation of Chile’s water management regime is that, by stepping out of the water market, the state allows the market to freely allocate water rights to the sectors of the economy that can make the most efficient use of them. In this way, water rights are allocated in an economically and, by extension, socially optimal manner. Thus, the only role of the state is to create the governance structure – the Water Code – that allows the market to function.
In this system it is critical that the governance structure be constructed properly because, in order for the system to function, there can be little state involvement beyond the initial rule setting. In other words, and as Chile is discovering if the initial structure is designed incorrectly, the government cannot intervene to fix it later because this intervention would undermine confidence in the market.
Market participants must have faith in the strength of the property rights established in the system. An overly activist state would undermine faith in the strength of property rights and thus the market for these rights. Therefore, because the Chile cannot intervene to correct flaws in the market, the Water Code must send the proper price signals. If the Code is written to structurally bias the market toward one economic use of water it is, by definition, sending an incorrect price signal that will lead to inefficient allocation of water rights.
Since the Water code only recognizes consumptive (municipal, industrial and irrigation) and non-consumptive (hydroelectric) rights, the Chilean water market does not consider additional economic uses and values for water. If water has an economic value not represented by these two rights the market is incomplete and thus inefficient.
And in fact, instream flows do have an economic value. In some locations, the economic value of instream flows may exceed the value of out-of-stream uses.
Increased instream flow due to dam removal in Idaho was found to have annual economic use values ranging from $193 million to $311 million with additional non-use values associated with the increased flows. In Colorado each additional Mm3 of instream flow was found to have an economic benefit of $17 in low flow periods. Now, this benefit declined to zero in high flow periods which points out an obvious economic lesson: there are flow rates above which water can be removed from the river without harming the value of the instream flows. However, once the flow rate is reduced past a certain point, there is an economic loss associated with further reductions. In order for water allocation to be optimal, this loss from reductions must be balanced against the gain from the activity causing the reduction. The market is only capable of determining this optimal level if the users of instream flows have a protected right to those flows and there is a price associated with these rights.
These examples are specific to the United States, but it can be assumed that there are similar values associated with instream flows in Chilean rivers. The intuition for this assumption is thus: most of the use value associated with the instream flows in other studies is due to the economic benefits associated with tourism. Looking at Chile, multiple studies of Chilean Patagonia have found that the annual value of tourism in Patagonia is greater than USD80 million. It is clear that not all, or even most, of that money can be attributed to instream flow. But, with one of world’s best whitewater rivers in the Futaleyfú and numerous other locations to raft and fish, it is certain that instream flow does have economic value in Chile.
Although the Water Code enshrines a system that depends on the market to operate, it is worth taking a moment to discuss the role of institutions in the Chilean water market. Markets never develop in a vacuum and the history and power of institutions have a lasting impact on both the development of markets and their execution. Although the state has little to no role in the Chilean water market, the courts play an important role in dispute resolution. In fact, it is the inability of the courts, the DGA, and local canal associations to effectively and fairly mediate disputes that leads to some of the most vexing problems with the water market.
The lack of an instream water right can be explained in part by the Chilean approach to water. In this view, water must be extracted, as with any other natural resource, in order to have economic value. This view is very strongly ingrained in the Chilean system and its institutions and is as much a reason for the current structure of the Water Code as a result of that structure; it is also incompatible with the idea of there being economic value to instream flows.
The interplay between the Water Code and Chilean institutions should make it clear that problem is too complicated for a simple solution; adding a new category of rights to the Water Code alone will not solve the problem of misallocation. The new rights will require equal protection in the courts in order to have any force or market value.
Thus, although structural reform of the Water Code is necessary – in the form of the addition of instream flow rights – it is important to note that adding rights to the Water Code is not sufficient. The Water Code is part of a larger system which is still very much dependent upon institutions. Reforming those institutions must also be a priority.
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