Chilean Water Markets: Part I

Note:  This is an edited version of the paper I just handed in for a course.  For the paper itself (along with the references, deleted here) email me.  The first part will go through the background of the Chilean water market and the second will discuss my biggest issue with the water market.  

In 1981 the authoritarian government of Augusto Pinochet overhauled Chile’s water market. The new Water Code (el Codigo de Aguas) shifted the previously state-run water sector to a new, free market model based heavily on the neoliberal ideas of Milton Friedman. The new water code instantly became the leading example of regulation by free markets, and neoliberal ideas in practice, in the world. The Chilean model was heavily promoted alongside the Washington Consensus in the developing world. By the late 1990s, however, there was increasing recognition that there were significant flaws with the Water Code and the World Bank, among others, began to examine the Chilean water sector more critically.

Criticism of the water allocation system focused on three weaknesses: (1) poor dispute resolution mechanisms; (2) a lack of water basin management frameworks; and (3) insufficient environmental protection. Within Chile, there was also concern over monopolistic and speculative behavior in the market for non-consumptive water rights. In 2005, these criticisms and the concern over speculation and monopolies led to a reform bill (Modifica el Codigo de Aguas) that adjusted the Water Code to address some of the flaws in the previous decree.

Thus, the current Chilean water market still serves as a leading example of the neoliberalization of natural resource management. But, where previously this system was praised, it is now recognized as having several critical flaws. A great deal of the scholarship on solving these flaws has focused on reforming the Water Code to weaken some of its strongest neoliberal tendencies and increase the involvement of the state. In the extreme case there have been calls for the re-nationalization of water. I argue that, in fact, correcting these flaws involves broadening the scope of the neoliberal tendencies of the Water Code, not weakening them. That is, articulating private rights in the Water Code for instream flows – defined as a right to a certain minimum rate of flow in the water body.

The Water Code defines water as a national good for public use (son beines nacionales de uso público) but water rights are unquestionably private property. These rights, once issued, are permanent, absolute, and are not tied to land titles. They can be traded, inherited, sold and are treated as any other type of real estate. Expropriation can only occur with explicit legislation and the state must pay market value for the rights. Furthermore, although the state – after the 2005 reforms – has the right to tax unused water rights, non-use of rights is not sufficient grounds to expropriate rights.

Water rights are issued by the Dirección General de Aguas (DGA), which must issue rights upon request if water is available and unclaimed. If there are multiple requests for the same water, the DGA is required to hold an auction. Requests for water need not specify to what use the water will be put. This has led several commentators to claim that the state does not prioritize one use above another and allows water to be put towards the most effective use as determined by the market. Others have criticized this stance, claiming that the code is not as fair as it appears. Indeed, the structure of Water Code implicitly values certain uses above others.

A final, critical part of the Water Code is the distinction between consumptive and non-consumptive rights. Non-consumptive rights were introduced into the Water Code as a means of encouraging hydroelectric development on rivers that had already had their consumptive rights allocated. These rights allow users to remove water from a body of water, use the water (ostensibly for hydroelectric generation), and return the water, unaltered, to the watercourse. Consumptive rights, on the other hand, allow the user to remove water from a body of water and use it however they like, with no requirement for return flows. There is also no beneficial use doctrine, as is common in other water regimes. Notably, consumptive and non-consumptive rights are the only two types of water rights outlined by the Water Code.

Chilean Water Markets: Part II

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.

Break

No new posts for a while - I'm currently traveling around the south island and can't be bothered writing.

An 800 lb (million dollar) Gorilla

The Boston Globe published and opinion piece over the weekend that broadly summarizes the concept of ecosystem services (unrelated: the Globe needs to get their internet act together.  This isn't the 90s anymore, come join the NYT and the WSJ in the 21st century).  I’ve been meaning to write something about this for a while so I suppose now is as good of time as any to do that.  I’ll start by saying that I thought that the piece was both fair and well informed.  It didn’t do the details of the issue justice, but as an introduction it was fine.  I’d dispute the tagline though – ‘ecosystem services’ is neither a new idea nor a particularly bold one.

As the article notes, it has been around since the mid-1970s, and in many ways the foundations of the idea have been around far longer than that.  At its heart, the principle of ecosystem services is nothing more than a recognition that humans are dependent upon services that are offered by the natural environment.  When we do not manage our activities to be in harmony with the surrounding environment we have a tendency to destroy these services.  As a result, a successful society is one that lives in harmony with the earth and recognizes that it is a system, of which we are only a part.  Sound familiar?  Granted, the introduction of money into the system is a new twist, but I can’t be the only one who sees more than a little irony in the fact that the West, and America in particular, is just now coming to this view.

Ironic or not, our gradual awakening to the fact that primitive societies might not have been as primitive as they seemed is very important and not without controversy.  As Tuhus-Dubrow and numerous others have noted, there is significant pushback against the idea of ecosystem services from some environmentalists.  Arguing that nature is much more than any dollar value we could assign it, they argue that our time should not go towards assigning dollar values but advocating for the protection of nature because of it’s priceless value to humanity.  While I tend to agree that there are many more reasons to protect the environment than the services it provides for humans, I reject the argument that we should not be assigning dollar values.  If we argue that nature should be protected because it is priceless there is a very real danger that it will not be protected precisely because it is price less. 

Not everyone sees nature as a priceless asset.  Unless a dollar value is assigned to at least some of it, then it will be given a zero value.  I see the problem as more severe than the justification, given in the article, that nature is given a value of zero by default.  That presumes people haven’t thought about the value of nature but, if they did, would give it more than a zero value.  I don’t believe that.  A large part of society will, and does, actively assign a value of zero to the environment – and in some cases assigns it a negative value in that they view the taming of the wild as progress.  This view cannot be countered by the argument that nature is valuable because we can’t value it.  It must be countered with specific and quantifiable data. 

However, the usefulness of ‘ecosystem service’ valuation is not limitless, nor are those who oppose its use entirely wrong.  They correctly point out the danger, in assigning dollar values, that the objects to which the dollar values are assigned become nothing more than those values.  When it becomes economical to replace them, based on the estimates of their value, they are replaced with no consideration for intrinsic value. 

While correct, this is not a reason to avoid ‘ecosystem services.’  Rather, it is the reason why ‘ecosystem services’ must be stressed as the minimum possible value that these things have, and that decisions to eliminate them must encompass many more variables.  The U.S. Department of Transportation has reduced human life to a numeric value – in the low millions – and uses this to assess whether certain policies should be enacted.  No one would argue that human life has hence been reduced to a numeric value.  Nor, I would suggest, that this statistical value of a human life is the only consideration in policies that may cost human life.  Nature can, and must, be dealt with in the same way.  Assigning values is only one part of the process but it is a vital one.  Without quantifiable data environmentalists are fighting an uphill battle against those who speak in dollars and cents. 

Finally, because I think that there is an important caveat to the discussion that is often glossed over – and certainly was in the article – I’ll leave you with the idea that there are two categories of environmental goods.  There are those that have a clear value in our current economic system but are not accurately priced, and those that currently have no clear value (and, obviously, are not accurately priced).  The first category includes things like mountain views (of which I am particularly fond) and carbon emissions.  These are goods that can, with some ingenuity, be accurately priced and included in our markets.  That they are not represents a significant market failure that should be addressed (especially with regard to carbon emissions).  The second category includes things like wildlife, wilderness, and a pristine environment.  These things can be valued – an African mountain gorilla was recently valued at USD 4 million based on tourism revenue – but the fact that they are not does not necessarily represent market failures.  I believe that having a value in these cases is still useful but one must be much more careful about the terms of the discussion.  A gorilla should be protected for its own sake, not just because it brings in 4 million from tourists. 

Trade for Development

So the conference that I was involved in earlier in my trip had a follow-up session this weekend.  The end result of that conference was a short statement we gave this afternoon.  I don't want to write the whole statement in case other people at the conference have issues with that but I'll post the section that I had a hand writing.  Enjoy.

______

 

The reasons why climate change is a slow crisis are obvious - it's invisible, it doesn't directly affect individuals, and it is very technical.  Poverty is none of these things.  2 billion people live in poverty and we all know it.  Why are we still struggling to address it?  By 2020, 3 billion people will live in poverty.  Poverty is as much a crisis for our generation as climate change.  

So what do we do?

We must tackle poverty with the same collaborative urgency needed to stop climate change.  This will mean redefining success to be more than simply GDP growth but also about finally taking responsibility for all of the effects of trade agreements. 

Now, while trade is not the only way to solve poverty, it is through trade agreements that governments deal internationally with economic issues.  It is the driving force behind the NZ-US partnership that brings us here today.  As a result, trade agreements in the future must deal effectively with poverty. 

Trade agreements must be reoriented to emphasize international development as well as profits. 

Applying our definition of success in this context we want to see a global trade agreement in which trade barriers - both tariff and non-tariff - are eliminated in the developed world with respect to the developing world.  In practice this would mean that countries with the highest GDPs and highest per capita GDPs eliminate barriers on goods from countries with both a lower GDP and per capita GDP.  It directly promotes development by allowing the developing world access to the markets of the developed world while at the same time giving them control over their domestic industry.  

The reasons why this benefits the developing world are obvious.  It is less clear why the developed world would, or should, get behind this.  The answer comes when you see the long-term elements of the program.  

The leaders of today are benefiting from the leadership of the last generation; who took specific actions to help China open to the West.  Today Starbucks makes more money from their stores in Shanghai than in New York City.  By 2015 they will triple the number of stores they have in China.  

If the current leading generation reorients trade towards development it will lead to the same benefits for our generation.  It is an investment by the developed world in the global future that will pay dividends for our generation.  

For too long the West has made decisions on very short time horizons.  It is now time for leaders to recognize that there are long-term benefits to development for everyone and if trade is the chosen medium to reduce poverty and promote development it must be fair and equitable trade. 

The first step in this process is crafting a bi-lateral agreement between the US and NZ in which the US truly opens its markets and removes all trade barriers.  It means providing labor protection for those who will lose in trade, financed in part by those who win from trade.  It means that NZ, in turn, opens its markets to those in the rest of the Pacific basin who are still struggling in crippling poverty.  

Such a relationship will serve as the first step in crafting global trade policy that equitably addresses poverty and leads to global growth, an inclusive society, a sustainable environment and is truly successful.

Bill Gates Could Save Biodiversity

Well, not quite. More accurately he could put up the first two and a half years of capital to preserve at least 10% of the land in every major climactic region on the planet (although with climate change his selections may not stay in their climactic region for very long). In a paper published in Nature in 1999 it was estimated that 15% of the world’s land area – the roughly 5% currently protected plus 10% strictly preserved to protect biodiversity – could be purchased and managed for roughly 23 billion annually. Bill Gates is worth somewhere between 50 and 55 billion dollars (and that is personal wealth, it doesn’t consider what he could mobilize through his foundation). The math is quite easy: 23 billion + 23 billion = the first two years of protection and some pocket change.

The numbers are even more impressive if you consider Warren Buffet’s wealth as well. Gates and Buffet have recently been involved in some high profile lobbying of the extremely wealthy, trying to get them to give away their money. So assume Buffet joins Gates in a quest to save the natural world. Between the two of them they have around 100 billion. That would get the project started and almost five years of funding and by that time I’m sure they could pull in some other donors.

Yes, it will never happen. But it’s a nice thought. No one is quite sure what Gates and Buffet plan to do with all of their money but they could have a massive impact on global conservation if they were to direct even half of their money that way. Today the global budget for wildlife conservation is less than 10 billion dollars. Imagine what could be done if that were doubled or tripled.

The nearly microscopic size of the current budget is the real take away from all of this. The U.S. alone has spent more than 15 billion a year in direct farm subsidies since the mid 1980s. We spent a little less than 10 billion a year on oil and natural gas subsidies from 2002-2008 and that hasn’t changed much since 2008. Neither of these is a necessary subsidy. In fact, have significant distortionary effects on global markets and, arguably, the competitiveness of the U.S. economy. If either or both were eliminated and the money shifted to conservation the impact on conservation efforts would be colossal. Again, it will never happen but it doesn’t hurt to think about where our priorities are and where they should be.

The Ants Go Marching Hurrah, Hurrah

So I was watching BBC Earth last night and saw an interesting piece on insects around the world.  One of the species they talked about in particular was the grass cutter ant.  These ants live in colonies of up to 8 million individuals across South America and Africa.  What caught my attention, however, is the system the ants have developed to produce their own food.  They are, in effect, (ant) farmers.

Within any given colony there are several different types of ant, from scout to cutter, that each of defined roles within the community.  Of primary importance here are the cutters.  They venture out from the colony and harvest up to 34 lbs of grass a day to bring back to the colony.  However, they are incapable of digesting the cellulose in the grass.  So, instead, they coat the grass with their saliva and feed it to the fungus that they cultivate underground.  They then eat the fungus.

All of this is quite cool but then things got really interesting.  See, when the fungus grows it produces CO2.  Because the ants respirate and because the fungus is grown in closed spaces underground this is a problem for the ants.  Left alone the CO2 would fill the colony and the ants would suffocate.  So the ants have created a rather unique system to ventilate their colonies by taking advantage of pressure differences between the areas where they grow fungus and dirt towers they construct on top of their hives.  This causes air movement across the fungus and clears out the CO2 and keeps the ants from killing themselves through their own farming.

The parallels should be obvious.  Now, I’m not suggesting that we ventilate the earth by poking holes in the atmosphere and letting all the CO2 out.  But it is nevertheless interesting to note that we are not the only species with this problem of CO2 production.