38205 October 2006 · Number 95 A regular series of notes highlighting recent lessons emerging from the operational and analytical program of the World Bank`s Latin America and Caribbean Region. The Role of Water Policy in Mexico1 Sustainability, Equity, and Economic Growth Considerations Musa Asad and Ariel Dinar Background Water resources management is one of Mexico's most long-term availability; (ii) distorted prices, subsidies, urgent environmental and resource problems, and one and/or other incentives in the water and related sectors that imposes heavy costs on the economy. The country encourage unsustainable water resource use practices is slightly less than 2 million km2 in size and the popula- and discourage water allocation to its highest productive tion has quadrupled from 25 million in 1950 to over 106 uses; (iii) laws, regulations, policies, and investments million in June 2005. Population growth has occurred that create the conditions for unsustainable water use nationwide, but because of internal migration it has been and/or distortions often result in an inequitable allocation greater in the semi-arid and arid north, northwest, and of fiscal resources. central regions, which are pre- cisely the regions with greater More specifically, nearly economic activity and where 80 percent of Mexico's water is scarce. The resulting rapidly growing population increased demand for water, is now concentrated in the combined with more intensive northern and central areas, use of water (stimulated in which account for over 80 part by price distortions and percent of GDP, over 90 relatively weak monitoring percent of irrigation, and 75 and enforcement arrange- percent of industrial activity. ments), has led to insufficient Institutional arrangements water availability to support to address the consequent natural ecosystems, and seri- increase in demand for water ously constrains growth in resources are inadequate. many areas. Water prices, as well as electricity prices for pumping groundwater, do not reflect water scarcity. Thus, Mexico has demonstrated many accomplishments in the Mexico now faces a "water crisis" that includes the water sector, including a comprehensive legal system, a overexploitation of 102 of its 653 aquifers, accounting national water authority, a functioning water rights sys- for more than half of groundwater extraction in the tem, and an incipient water market. However, the coun- country. The National Water Commission (CONAGUA) try's water sector still faces significant challenges. These estimates groundwater overextraction at almost 40 include issues of sustainability, economic efficiency (or percent of total groundwater use. The value of the limits to growth), and equity. For example: (i) increasing overextracted groundwater in agricultural production and continued overexploitation of water resources has alone is estimated at more than US$1.2 billion or 0.2 significant negative impacts on the resource's near- and percent of GDP. The depletion of many aquifers leads 1 - This note is extracted from the synthesis of the various studies feeding into the Economic Sector Work, "Mexico Assessment of Policy Interventions in the Water Sector". A more detailed summary appears as Sustainable Development Working Paper No. 27. available from http://www.worldbank.org/lacruraldevelopment to nonprice and unregulated rationing, distorting growth in Mexico's most dynamic economic regions. Some Box 1 - Water as a Limiting Factor to Economic Growth apparent contradictions between the Constitution and Trade and Competitiveness. As Mexico's economy national water laws and regulations further complicate becomes increasingly open, regional and international opportunities for economic expansion are growing. this sort of rationing, particularly in relation to However, such opportunities have not been fully pursued, disenfranchised populations. in part due to (i) inadequate incentives to improve water use, such as moving water from low to high value uses, Although some irrigation is shifting to water-saving and (ii) the water rights administrative system in place that technologies, the shift is limited, and the crop mix makes it difficult to trade in water and to adjust water use to sectoral demands and market signals. As foreign supply remains largely the same because (i) water and electricity and demand enter the picture, the rational reallocation of prices still give the false signal that water is abundant, production should move toward more water-productive and (ii) irrigation infrastructure is insufficient to allow activities, if there are relatively free market prices for water farmers to shift to specialty crops. Moreover, agricultural as well as for goods and non-water inputs. Products with greater water intensity would be imported from places producers benefit from low electricity tariffs for with more water, and Mexico would specialize in tradable pumping. Consequently, farmers have little incentive to products that need less water. The transmission of such change current practices, which result in overpumping information and incentives (including those for water) to of aquifers, lowering of the groundwater table(s), and in producers in a market­driven economy would take place many cases the intrusion of salt water. In addition, the through changes in relative prices. However, this has not happened for the most part, and the specialization of financial cost to society of the nearly US$700 million per production within the nation's agricultural sector has shifted year electricity subsidy may represent only a fraction of toward, not away from, water-intensive activities. Irrigated the full economic cost, since environmental degradation production in agriculture increased its share from 45 to 55 is not valued properly. percent during the 1980s and 90s, and now accounts for about 70 percent of Mexico's agricultural exports. In summary, with water in Mexico becoming very scarce spatially and over time, it is now a factor that The study reported in this note is part of a broader limits economic activity and social well-being in several analysis of the sector. Its intent is to promote a regions. The identification of priorities and trade-offs stakeholders consultation process, development of a in relation to water allocation requires careful and specific set of background papers to address the most timely attention to address an ever-growing range pressing issues in water policy in the country. Finally, of complications arising from the impact of various the study included the development of analytical models interlinked considerations, such as sustainability of to assess the linkages and impacts of various policy water resources, fairness, pollution, environment, basic instruments on the water sector and the economy with a services, development, competition, and globalization. focus on one river basin case study - Rio Bravo. National policies, both within the water sector and for the overall economy, need to accommodate these issues. Main Issues and Findings Otherwise, the trend in undervaluing and overexploiting The main issues and findings of this study corroborate water resources will lead to increasingly significant negative lessons learned from international experience. Namely, impacts on the overall economy and society (Box 1). there is a need for a comprehensive and well-coordinated set of interventions that address issues of sustainabil- Objective and Methodology ity, equity, and economic efficiency (or constraints to While the issues described above may be familiar to growth). many experts in and outside Mexico, understanding of the economic implications of possible solutions is far less Considering the overexploitation of aquifers, combined obvious. Moreover, agreement on the multisectoral solutions with rapid urban growth, it seems unlikely that preserving required to fully address these challenges has not yet been current water allocations for agricultural uses can be reached. Consequently, the need for a comprehensive sustained. Part of the complication arises from allocating framework to allow various relevant stakeholders to assess much more water for agricultural uses relative to urban uses. and prioritize policy interventions is essential. As such, meeting urban demands would likely only require small reductions in available water for agriculture, leading 2 · October 2006 · Number 95 to moderate reductions in total cultivated land and level of production. Moreover, some policy interventions to achieve Box 2 - Economic Value of Water (EVW) this result have relatively lower negative impacts than Policy makers can learn a great deal from a relatively others, so they are more politically acceptable. simple analysis (tool) that provides the economic value of water (EVW) across uses and regions. The reported values give policy makers a signal about the performance of the Farmers seem to be quantity-responsive rather than policies leading to a given allocation of the water among price (cost)-responsive to both land and water. In other various sectors or various regions in the economy net of words, given current pricing and subsidy realities, policy transaction costs. These transaction costs include the cost alternatives that target irrigation water supply reduction of pumping water, the cost of transferring water rights, and various indirect costs. The EVW prioritizes water uses (rather than irrigation water supply price increases) may based on their water productivity. However, transactions be more likely to induce greater water use efficiency for costs can be substantial and make unfeasible those water agricultural purposes. Moreover, reducing water supply can reallocations that would otherwise seem economically fea- be implemented more equitably, and would therefore be sible. Therefore, the usefulness of an EVW analysis lies in its broad basis for dialogue among various stakeholders more politically viable, compared to policies that focus on and its flexibility to incorporate alternative policy interven- eliminating energy subsidies for pumping groundwater. As tion considerations and their costs compared to poor and medium income rural households, rich Mexican rural households (especially those in the North economically efficient water allocation. However, such and in the Río Bravo Basin) are the ones that are most transfers would require an adequate legal, institutional, affected when water availability is reduced and when water and regulatory framework to be in place. Findings from costs increase. the comparative analysis of water­related policies suggest The economic value of water analysis (Box 2) that such a framework may need to be strengthened to demonstrates substantial differences in water assure that trading of water rights is feasible, viable (i.e., productivity across various agricultural products, that the associated transactions costs are not prohibitive), among different economic sectors, and in different areas and transparent. Otherwise, purely informal water markets within the Rio Bravo region. This imbalance implies that may remain relatively marginalized and localized and/or may lead to inefficient and inequitable results. distortions remain in terms of productivity, efficiency, and equity for the regional economy as a whole. Improving Other important limitations to efficient, equitable, crop production techniques could address much of that and sustainable water allocation include pricing distortion, in terms of both water savings and increased and subsidy distortions. The analyses of farm types physical output. Improvement, diversion, or substitution and groundwater pumping subsidies demonstrate, in of forage and grain crops (i.e., alfalfa, sorghum, and particular, that the Tarifa 09 subsidy for electricity1 pastures) may lead to similar favorable results if adequate negatively impacts both the agricultural sector, the infrastructure and markets are in place. environment and the entire economy. Moreover, the main beneficiaries are farmers who have groundwater Similarly, the review of the cost of providing and the will- ingness to pay for water suggests that improving the per- concessions, i.e., only about 30 percent of all farmers formance of utilities could lead to increased water sav- in Mexico. With the cost of the subsidy reaching nearly ings, as well as better delivery of water supply and sani- US$700 million in 2004, this sort of distortion can no tation services (including for the most vulnerable). The longer be overlooked. However, simply eliminating the subsidy would not likely be politically feasible, municipal and industrial water use analysis highlights the nor would it be particularly efficient in the context scope for such improvements, which would lead to better of existing institutions in Mexico. On the other hand, sustainability of water use by reducing water losses in the several alternative policy interventions may be more or system. Policy interventions regarding pricing, bill collec- less politically neutral, as well as efficient and equitable. tion, leak-and-detect management, and performance­based incentives for utilities require greater consideration. 1 - Tarifa 09 - The average cost of producing electricity in Mexico is 0.61 pesos (10.7 pesos/US dollar) per kilowatt hour (KwH) without considering additional transmission costs. The fee for a farmer benefiting from a concession is 0.22 Transferring water among crops, water rights hold- pesos per KwH (Tarifa 09-CU), which corresponds to a subsidy of 63 percent ers, and basins could also lead to more equitable and (other subsidies are also included under Tarifa 09, such as the night rate October 2006 · Number 95 · These include the following options: (i) "decoupling" of poor rural households. The above is particularly important so that each farmer receives the average subsidy; for the portion of poor rural households that are indigenous, (ii) allocation based on historical consumption; (iii) that is, for the poorest of Mexico's poor. assigning subsidy benefits only to water concession holders, thereby stimulating a more efficient and legal Free trade policies may facilitate many of the policy use of water and electricity; and (iv) a combination alternatives discussed above. For example, the negative of one of the preceding options with a payment per impacts from restricting water supply for irrigation would hectare approach to further target the subsidy. Each of be relatively low compared to the positive impacts from these options has political economy consequences that agricultural trade liberalization. These impacts may offset would need to be considered in the context of the policy negative consequences to richer rural households whose dialogue which the present study is intended to inform, incomes are the most affected when water availability is but none of the options would be as politically charged reduced and/or water costs increase. The same holds when as eliminating the subsidy altogether. a value-added tax on foodstuff is introduced and/or when agricultural subsidies to certain crops are eliminated. For Inequitable water allocation also seems to arise from example, reductions on water supply for irrigation in a centralized water policy and investment decision context of free trade are less harmful to rural households making that inherently marginalizes certain elements than the elimination of the farmers support program, of the overall society. The analysis of water management PROCAMPO. policies in indigenous communities indicates that the omission of the sociocultural dimensions of water not only Analysis of the existing legal and policy framework makes contemporary indigenous civilizations vulnerable, but highlights the fragmented nature of the sector, the also negatively impacts overall water resources management. limited institutional capacity, and the lack of incentives Many indigenous communities have adapted to cost- to meet national objectives. If institutional, legal and effective and sustainable water management practices. regulatory, and monitoring and enforcement arrangements However, these communities remain marginalized from are not adequately addressed, few if any of the policy water sector policy and investment decision making. Such alternatives the present study seeks to identify would be marginalization inevitably generates conflicts over water effective. Broad regional interventions that could create and leads to various negative impacts that upset the overall market­based incentives, such as a tradable water rights fabric of society at large. Ironically, indigenous communities system, require strong institutional, legal, regulatory, and are often strategically located in regions with high levels monitoring and enforcement mechanisms to function of biodiversity and natural resources, as well as aquifer well. Performance­based incentives to improve utilities recharge zones, precisely those areas that require greater would be most effective when adequate monitoring attention under the current "water crisis" circumstances. and enforcement arrangements are in place. Targeted However, public resources allocated to improve basic needs interventions would be most beneficial when combined in indigenous regions remain far below the millennium with an appropriate legal, regulatory, and institutional development goal of US$550 per capita needed to resolve framework that assures the right pricing signals. drinking water and sanitation deficits in these regions. Climate change is likely to affect Mexico with Many negative impacts that may result from reducing differential impacts by regions. Localized policies seem irrigation water supply can be offset by improved water appropriate to address the fact that impacts from changing use practices. Allowing Water Users Associations (WUAs) water availability vary across regions, households, and to retain revenues from water charge collections and locally cultural groups. reinvest the proceeds raised by charging fully according to the value of water in water-productivity improvement technologies. Policy changes that imply more resources About the Authors to the WUAs and to the government, could improve Musa Asad is a Senior Financial Analyst with the Environmentally and government finances and be used for redistributive purposes; Socially Sustainable Development Department of the Latin America and the Caribbean Region and Ariel Dinar is a Lead Economist in the Agriculture for example, by promoting a more efficient crop production and Rural Development Department, both within the World Bank "en breve" is produced by the Knowledge Team of the Operations Services Department of the Latin America and the Caribbean Region of the World Bank - http://www.worldbank.org/lac 4 · October 2006 · Number 95