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UNIVERSITY OF ROME “LA SAPIENZA”
Centro Interdipartimentale sul Diritto e
l’Economia dei Mercati
The Economics of Water
Efficiency: A Review
Amman, September 30 / October 4, 2005
Andrea Billi, Giovanni Canitano, Angelo Quarto
A multi-faced approach to
water efficiency

Physical (absolute) efficiency: using the least
possible amount of water


Hydrological/engineering approach: focuses on the way
to divert water sources to satisfy all demand using less water
Economic efficiency: derive the maximum net
benefit to society

Economic approach: focuses on costs and values to
balance supply and demand
– Stand-alone welfare calculations
– Multi-objectives mathematical programming


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Institutional efficiency: assess the functioning of an
institution regarding water
Environmental efficiency: optimal natural resource
conservation
Technological efficiency: extracting more valuable
products for the same amount of inputs
Why using an economic
perspective?

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Water is unevenly distributed and its allocation is
controversial, thus it is an important policy issue
Most planners have biased or uniformed opinions about the
hierarchical order of water uses to be satisfied: scarce water
should be allocated to the most valuable sectors
There are many interdependencies between the water
sector and other sectors
There are techniques to chose among several arrays of
alternative and complementary water projects (supply
expansion, demand management) for adapting demand and
supply to local circumstances
Cost recovery and financing issue are key aspect of a
modern water investment policy
Key concept on economic
efficiency of water use


Equal marginal values: allocate water so that all users
and consumers derive the same value at the margin
Marginal cost pricing: use water up to the point in
which its marginal value is equal to its marginal cost
the 2 principles give the right
incentives to use water wisely

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The market process automatically satisfies both
conditions
When public policy dominates, the political process
should mimic the market process
 economic analysis helps taking informed
decisions on water projects and policies
The basics of the economic
analysis of water
The hydrosocial water
cycle
Territory of Reference
Returns
Returns
Abstraction
Evapotranspiration
Sea
Sea
Re
tur
ns
Re
tu
rn
s
Sewage and refuse
disposal...
io
ct
ra
st
Ab
Households
n
Sources of
demand
values
 Sources of
supply
costs

Returns
In situ use of
precipitation
Abstraction
Physical Water Resource System
Abstraction

Atmosphere
Other Industries
(incl. Agriculture)
RoW
Economy
Imports
Collection, purification
and distribution of water;
Transport via pipeline
RoW
Economy
Exports
Economy
The demand for water in
WASAMED countries
Water withdrawals, total pre-capita and by sectors
1998-2002
Major
water
consumer
Households (%)
Agriculture (%)
Industry (%)
Total water
withdrawal per capita
(m3/inhab/yr)
Algeria
21.91
64.91
13.18
194.1
Cyprus
29.17
70.83
0.00
301.5
Egypt
7.76
86.38
5.86
968.7
Germany
12.35
19.79
67.86
570.9
Greece
16.34
80.44
3.22
708.3
Italy
18.19
45.10
36.71
771.9
Jordan
20.79
75.25
3.96
189.5
Lebanon
32.61
66.67
0.72
383.8
Malta
79.21
19.80
0.99
128.5
Morocco
9.76
87.38
2.86
419.0
Palestine
-
-
-
-
Portugal
9.59
78.24
12.17
1,121.0
Spain
13.44
68.03
18.52
869.5
Syria
3.31
94.89
1.81
1,148.0
Tunisia
13.83
82.01
4.17
271.4
Turkey
14.81
74.23
10.95
533.7
Mean
20.20
67.60
12.20
571.9
Std. Dev
18.08
22.63
18.12
342.9
Source of data: FAO AQUASTAT
Generic water
demand
function
D( p) 
n

i 1
Li qi ( p )
Four approaches to water
valuation in agriculture

‘Farm budget’ approaches
– Residual imputation
– Change in net income


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Farm budget: theory of cost-minimizing producer, optimal
water use patterns, programming methods  the Value of
Marginal Product (VMP) is equated to price or marginal cost
Incremental benefits: net benefits with the project less
net benefits without it
Other approaches
– Value added
– Alternative cost
Accounting for efficient
water use

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The water sector interacts with all other sectors of the
economy, and could become a binding constraint
Water accounting registers the flows of water over time
in and out of the physical system and the economy
Water is treated as an asset, whose stock is calculated
at the beginning and at the end of each given period
The objective is to provide a large amount of data by
disaggregating water inflows and outflows per supply
source and demand sector, so that:
– specific water accounting indicators can be calculated
– more sophisticated estimations can be performed
Modeling water policies
Integrated economic-hydrologic models

The most advanced tools for water policy analysis

Take into account at the same time of:
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natural and physical processes
structure of the economy
proposed project / policies
institutional setting
Under a set of constraints:

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The
The
The
The
Natural (soil, water)
Political (minimum allocations, subsidies)
Institutional (prices, property regime)
Financial (investment restrictions)
Two types of nested models:


Simulation: model the response of the hydro system to nonequilibrium conditions
Optimization: maximize an objective function given the constraints
Structure of integrated
models: node-link

Three types of components (nodes)

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Sources (rivers, canals, aquifers)
Demands (off- and in-stream)
Intermediate facilities (storage, treatment and recycling)
The components are connected through the
network infrastructure (links)
Water demand is determined endogenously
Water supply is given by the simulation model
Externalities (ex: salinity of return flows) are
taken into account
Elements of constrained
optimization


Maximize the present value of farmers’
profits at each demand site over a
chosen time horizon
Based on the crop-water functions
m
PA 
T

t 1

j 1
A jY j Pj 

m

A j Fc
j
j 1
1
 r t
 Tc
j

Q Wt PWt
Disadvantages of
integrated models

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Complexity (but can be simplified for
broad policy assessments)
Insufficient data (but steps could be
envisaged to improve the models)
Very site-specific (but can be
generalized)
Indicators

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Physical indicators of water use efficiency
are limited in that either high or low values do
not tell anything about the economic
implications (higher or lower benefit to
society)
Economic indicators and indices of water
use efficiency combine physical and economic
data and also account for multi-period
relationships
Policy-related indicators of water use
account for how water is used to meet social
goals (ex: poverty alleviation)
Main economic indicators

Water productivity:
PR W 
m

j 1

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Standardized Gross
Value of Production:
Profit per unit of
water consumed:
Cost recovery rate:
Zj
Q Wj


P
i
P
SGVP  
A i Pi
world
 crop

P
b 


PUW dm 
 WD
PA dm
dm , t
 RF dm , t
time

CRR  TR  S
TC
  100
Directions for the future

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Improve data collection
Maintain regularly a water accounting
perspective
Carry out routinely the economic
analyses
Make use of Spatial Decision Support
Systems (SDDS), as a combination of:
Decision Support Systems (DSS)
 Geographic Information Systems (GIS)

Thank you!