Economic instruments vs control in water management


Water is a finite resource and to ensure sustainability of this critical resource effective management is essential. To ensure sustainability of water, good governance must be applied to manage this resource. Because of the nature of water negative externalities can affect the availability and quality of this resource in the market. Negative externalities can be defined as the negative effect that a product or firm imposes on a third party. To ensure that the market functions effectively and efficiently the firm or product must include the social cost of the negative externality into their total cost. For this negative externality to be factored into the total cost of the firm or product several techniques can be utilised. These techniques can be broadly placed into two categories, command and control instruments and economic instruments. Efficiency is considered to occur when society receives the net benefit from the utilisation of the resources. Command and control instruments are direct regulations that are utilised to manage negative externalities, while economic instruments are market based approaches. In the past water managers have found it useful to utilise command and control instruments to manage negative externalities that occur in water resources market. This has proven to be useful depending on the situations and type of externalities. However, economists have been increasingly suggesting the utilisation of economic instruments to manage environmental problems. This paper will look at various types of command and control and economic instruments that can be utilised in water resource management. It will highlight some of the advantages and disadvantages of using both instruments and then it will conclude by looking at how both command and control and economic instruments can be effectively utilised to improve management in the water sector.

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Water is fast becoming a scarce commodity in many countries worldwide. According to World Wildlife Fund International (2003) water supplies around the world are declining while the demand is drastically increasing at an unsustainable rate. Approximately 1.5 billon people worldwide lack access to safe drinking water and it is suggested that if current consumption trends continue approximately 3.5 billion people will reside in water stressed river basins in 20 years. It has been suggested that approximately half of the world's accessible freshwater has already been consumed and by 2025 nearly three quarters of this resource will be consumed. Estimates suggest that approximately 2.2 million people die annually from disease related to contaminated drinking water and poor sanitation. High pollution levels, unsustainable utilisation of water resources and degradation of ecosystems can be blamed for water scarcity that is being experiencing worldwide. 3.3 billion people are denied access to clean water supply as a result of contamination while 90% of wastewater in developing countries are discharged directly into rivers and streams without treatment (World Wildlife Fund International, 2003).

Economists suggest that most environmental and natural resource problems occur as a result of market failure. Market failure is defined by Khan (1998:14) as the "inability of the market to allocate resources efficiently." He further suggests that market failure creates a divergence between private cost and social cost. There are several categories of market failure that causes environmental and natural resource problems, these includes imperfect competition, imperfect information, public good, inappropriate government intervention and externalities. Market failure occurs as a result of imperfect competition when the individual actions of either buyers or sellers affect market price. If one segment of the market is not aware of the true costs or benefits of market goods, market failure can occur as a result of imperfect information. Public goods can cause market failure when the market fails to provide the socially optimal cost. Externalities are classified as unintended consequences experienced by a third party as a result of market transaction and they can either be positive or negative (Khan, 1998). Khan suggests that in most cases pollution occur as a result of negative externality.

To ensure that the market functions effectively the firm or product must prevent market failure from occurring, utilise the product sustainably or include the social cost of the product or service into the total cost. Managers of water resources have through the years utilised several techniques to ensure sustainable access and management and to reduce the rate of point and nonpoint sources of pollution. Two such techniques that have been utilised are command and control instruments and economic instruments or market based instruments. Command and control instruments are defined by Austin (1999) as the utilisation of standard based systems for the control of environmental problems, in most instances uniform targets are set and in some situations the process for achieving the targets are also stipulated. Generally command and control instruments are usually specific regulations and permissible technology that have rigid regulatory requirements. Stavins (2001) defines market based instruments as regulations that utilised market signal rather than explicit directives to encourage pollution control levels and methods. He also highlighted that these instruments should harness market forces because they should be well designed and implemented and encourages firms and individuals to undertake pollution control efforts that are in their own interest. This paper will review several types of command and control and economic instruments that are utilised in water management and will highlight case studies where these instruments were utilised. It will then conclude by looking at how both command and control and economic instruments can be utilised for better water management.

Command and control instruments

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Porto (2004) suggests that command and control instruments are traditional instruments that utilised a compulsory application approach and in most cases are applied to attributes that cannot be delegated and are exclusive to the state system. Generally command and control instruments can be classified as either standards or regulations. With the application of command and control in water management a standard is set indicating for example the maximum level of pollution that can be released into a body of water. The control aspect of these instruments deals with the management and enforcement of the standard.

Standards can either be ambient standards or emission standards. The ESCAP (2003) defines ambient standards as the minimum desirable level of water quality or the maximum level of pollutants that must be maintained. Canada has an ambient standard for the maximum allowable concentration of boron in drinking water and livestock watering. This standard is set to prevent both man and animals from suffering the ill effects of high levels of boron in water (Moss, 2003). ESCAP (2003) stated that emission standards specify the maximum level of permissible emission and can either be performance based or technology based. The main difference between performance based standards and technology based standards is with performance based standards they stipulates the allowable emission limits while with technology based standards not only emission limits are stipulated but the technology that must be utilised is also stipulated. Generally performance based standards are more prevalent that technology based standards (ESCAP, 2003).

Advantages of command and control instruments

Standards offer the immediate reduction of pollution especially if effectively monitored.

With technology based standards it offers polluters the stipulated technology to reduce pollution therefore polluters do not have to research the possible utilisation of technology.

Because command and control instruments have been utilised for an extended period of time they are more readily understood and applied to control pollution in water management.

Command and control options offer the ideal solution when there is uncertainty about the possible effects of pollution and can be effectively utilised in periods of uncertainty.

It has been suggested that the political cost for utilising command and control option in water management is less costly than environmental instruments.

Disadvantages of command and control instruments

With the utilisation of command and control instruments there are no incentives for polluters to reduce pollution below the required standards. Cantin et al. (2005) suggests that command and control instruments offers little flexibility and limited incentive for innovation, it does not ensure that implementation of effective and efficient solutions.

Command and control instruments treat all polluters equally regardless of the quantity of pollutions that they are emitting.

There are no incentives for polluters to invest in technology to determine a less expensive way of reducing pollution with the utilisation of technology based standards.

Command and control instruments do not take into consideration polluters that are polluting less than the established standard. This results in polluters degrading the water resource and not having to pay the requisite abatement cost

To be effective standards need to be revised frequently to control pollution but generally legislations tend not to keep up with the necessary changes.

Because water is a non marketable good it is extremely difficult to determine an optimum standard.

The utilisation of command and control instruments can be extremely costly especially when the monitoring and enforcement component of this instrument is taken into considerations.

It has been suggested that the political cost for the utilisation of command and control instruments can be extremely high especially if it is stringent and businesses are negatively affected.

Case study

In Barbados the Barbados Water Authority Act (cap 389) mandated the Barbados Water Authority (BWA) to manage water resources in the island. They are responsible for the management, allocation and monitoring of the water resources of the island. This is done through the abstraction from 20 wells, 1 well field, 2 springs and 1 desalination plant. There is full national coverage of water in the island. To protect the aquifers from contamination the government of Barbados has established a zoning policy which dictates what development can be conducted according to zones. Zone 1 areas are the most restrictive which indicates that industrial, agricultural or some domestic constructions cannot be done in these areas.

Economic instruments

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Andersen (2001) suggests that Arthur Pigou is the founding father of economic instruments. According to Andersen Pigou suggested that the cost of environmental degradation should be factored into the cost of the goods, he then came up with the principle of polluters pay. Pigou's argument was that if pollution remains unpriced in the market there will be less optimal allocation of resources when compared to if pollution is properly priced (Andersen, 2001). Kemper et al. (2006) suggests that an economic instrument seeks to stimulate economic actors to voluntary adopt positive behaviours. They further highlighted that generally people in the market react to price incentives, when there is high prices it will force actors to demonstrate a more environmentally approach to utilisation of goods and services. When compared with command and control instruments economic instruments in water management are relatively new mechanisms used to control pollution rates. Regardless of its age, economic instruments are increasingly being utilised for pollution control in water resource management and integrated water resource management.

Whitten et al. (2008) suggests that the main reason for the utilisation of economic instruments in water management is because of the perceived potential to deliver the same outcome as command and control instruments but at a lower net social cost to society and lower financial cost to industries. MacDonald et al. (2004) defines economic instruments as a group of regulations that seeks to align private incentives with public natural resource management goals. They suggest that economic instruments seek to achieve environmental improvement for lower cost than prescriptive regulations or to create a market for environmental outcomes.

Whitten et al. (2008) suggest that economic instruments can be placed into three categories - price based, market based and market frictions (see figure 1). With price bases instruments the prices are altered to reflect the true cost of the good or service. These generally provide certainties in regard to the compliance cost of achieving an outcome however, the environmental outcome is uncertain. Generally right based instruments are utilised to ensure the quality of water or water services to a socially desired level. It is felt that these instruments can provide guarantee as to the environmental outcome but it does not provide certainty as to the cost to the industry in achieving the desired outcome. Economic instruments utilised to reduce market friction aim to stimulate the market to produce desired water resource outcome through improving the working of existing markets by reducing transaction cost or improving information flows. These instruments are less common because responses seem to be less certain and it take a longer time to achieve desired results (Whitten et al., 2008).

Figure : showing potential economic instruments levers (adapted from Whitten et al., 2008)

Price based instruments can be further subdivided into charges, fees, deposit refund systems and subsidies. Rights based instruments can be categorised into tradable permits and offset schemes, while market friction instruments can be subdivided into barriers, research programme and educational awareness (see table 1 for types of market based instruments). Sawyer et al. (2005) indicates that economic instruments can be utilised in water resource management to overcome four main challenges:

Scarce financial resources - in instances where a lack of finance limit manager's ability to make or encourage water conservation investments. It is generally found that economic instruments provide financial options to encourage and finance water efficiency and conservation investments.

Fiscal challenges - in cases where institutional budget limitations and cost recovery requirements are present and existing water revenues do not recover these cost economic instruments offers a possible solution.

Behavioural changes - in situations where there is a need to address water conservation challenges e.g. water scarcity, economic instruments provides the use of incentives to conserve water. Generally the incentives are utilised to change water users behaviour so that water manager's objectives can be realised.

Environmental challenges - economic instruments are utilised in cases where water users have not been paying the social cost that are generated on third parties. Economic instruments provide the opportunity to achieve a socially desirable solution so that external costs are included into the cost of the resource utilisation or resource access (Sawyer et al., 2005).

Advantages of economic instruments

Economic instruments provide incentives for the application of innovative technology for pollution reduction.

Economic instruments are more cost effective because they provide low costs options to society to control pollution.

Whitten et al. (2008) suggest that economic instruments offer cheaper ways to

Horbulyk (2005) suggest that economic instruments when compared to command and control instruments offer water users greater financial incentives to conserve or reallocate water.

Economic instruments provide the opportunity to decrease externalities and allow polluters to pay for abatement.

With economic instruments revenue is generated for abatement cost of water pollutants.

It provides the economic incentives for water consumers to reduce incidents of pollution.

Some economic instruments offer a voluntary scheme that seeks to change environmental behaviour at the lowest possible cost to government.

PRI (2005) indicated that economic instruments provide the opportunity to utilise market forces to ensure that most economically efficient way to achieve a given target.

Disadvantages of economic instruments

The utilisation of economic instruments can result in the increase of prices of goods and services since it factors in social coast of goods and services.

Economic instruments can be administrative intensive and it requires strong administrative institutions.

It can sometimes be difficult to determine the optimum economic instrument for non market goods and services in the water sector.

Whitten et al. (2008) indicated that several economic instruments have design issues that relate to regulatory and enforcement aspects of the instruments.

PRI (2005) suggested that one of the challenges of implementing economic instruments is clarifying the components of full cost pricing and clearly defining property rights and their legal context.

With the application of some economic instruments more firms can be attracted to the market which could result in an increase in pollution in the long term.

The water market might not be perfect for the application of some economic instruments.

Case study

Colombia in 1997 initiated a nationwide programme to reduce water pollution in the country. Rather than using command and control instruments requiring firms to cap emission of pollutants at specific levels economic instruments were utilised for emission reduction by charging polluters a fee per unit of pollution emitted. The use of discharge fees saw water quality in key watershed immediately improve. However, several problems were encountered in the implementation of this programme:

It was unevenly applied across the country and by 2003 only 9 of the 33 Corporaciones Autonomes Regioneles or regional environmental regulatory authority (CARS) had fulfilled all the principle requirements needed for the discharge fee. 13 CARs collected revenues but were not implementing the programmes in it completed or consistent manner and 11 had started implementation but had not collected fees as yet.

There was low fee collection rates with only 27% of fees that were invoiced collected and this ranges from 1% to 95% among CARs.

There was persistent non compliance by municipal sewage authorities. They were invoiced for more than 35% of all discharge fees; however, they only paid 40% of the invoiced amount. This resulted in private sector water dischargers complaining about the transparency of the process. The noncompliance of municipal sewage authorities prevented some water basins from meeting total pollution load reduction targets which led to steep increases in fee charged to all dischargers in the water basin.

The discharge fee system was applied without removing the pre existing command and control system of permits and discharge standards. This resulted in confusion and controversy about the relationship between the two policies.

In spite of all the challenges the programmes was deemed to be a success because there was significant decrease in pollution discharges. The Ministry of Environment indicated that during a five year period of the programme national BID discharges from point sources of pollution fell by 27% and total suspended solids discharges fell by 45% (Blackman, 2006).

Analysis of use

There has been increasing advocacy for the use of economic instruments in water management rather than the traditional command and control instruments. Many of these advocates have suggested that economic instruments are more efficient and effective than command and control instruments; however, Cole (1999) stated that to take this position would indicate insensitivity to historical, institutional and technological contexts. He indicated that those who suggest that command and control regulations are inefficient and will increasingly grow inefficient when compared to economic instruments usually assume perfect monitoring (costless) or that monitoring cost are the same regardless of the control regime that is chosen. These assumptions he suggested are unrealistic and it result in skewed cost benefit analysis in favour of economic instruments. He further highlighted that when institutional and technological cost are considered command and control instruments are not inherently inefficient or less effective than some economic instruments. Once monitoring cost are high command and control regulations are more efficient than economic instruments (Cole, 1999).

Cole (1999) cautioned against radical transformation from command and control instruments to economic instruments. He suggested that such a transformation can result in environmental degradation if resources available to regulators are not dramatically expanded in relation to the pressure that is placed on the demand to track pollution sources and rate of emission and their toxicological effect on the environment. He further indicated that when conducting cost benefit analysis to determine efficiency of command and control and economic instruments estimates of environmental costs and benefits are fraught with uncertainty and subjectivity, especially when valuing non priced goods and selecting the discount rate. However, when considering several command and control case studies, the US Clean Air Act most notable, it will be difficult not to conclude that they are effective and efficient. Economic instruments are not suitable for all institutions and technological context especially where cost for monitoring and enforcement are high. In these situations Cole suggested that command and control instruments are more effective and efficient (Cole, 1999).

Harrington (2004) indicated that there is a perceived efficiency in economic instruments when compared to command and control instruments. He further suggested that it has been found that economic instruments are more cost effective at reducing emissions; however, efficiency requires perfect competitions. In water management there is no perfect competition. Generally economic instruments give continued incentives for the utilisation of new technology. Command and control instruments encourage reduction innovations only while economic instruments encourage both cost reductions and emission reduction innovations. Harrington (2004) further suggested that command and control generally achieves the desired objectives faster and with more certainty when compared to economic instruments. Regulatory industries prefer command and control instruments and in most cases economic instruments have lower social costs but higher abatement cost to firms. According to Harrington it has been found that command and control instruments have higher administrative cost (Harrington, 2004). Cantin et al. (2005) suggest that economic instruments offers more advantage than command and control instruments because it is more flexible and it shifts the abatement cost to the resource users. In cases where command and control instruments are utilised polluters are often able to avoid abatement cost since they discharge permitted waste into water and the associated costs are borne by society. Whitten et al. (2008) suggested that the benefits of economic instruments should be compared to cost involved with the establishment of these instruments. He further indicated that economic instruments are context specific and to achieve benefits attention to detail is required in relation to existing policies and biophysical environment.

Conclusion and recommendations

Water is a vital resource for human existence and it is fast becoming a scarce commodity in many countries. To ensure sustainability of this resource good governance must be utilised in its management. This paper reviewed the utilisation of control and command instruments and economic instruments as a tool for good governance of water resource. It presented the types of command and control instruments and highlighted a case study where command and control was implemented successfully to achieve sustainability. The paper also reviewed the use of economic instruments in water management and presented a case study when one type of economic instrument was successful implement. It further compared the utilisation of command and control and economic instruments and highlighted their strengths and weakness.

For this analysis of the strength and weakness of command and control and economic instruments it can be said that both offers benefits for utilisation in the management of water. Both can be effectively utilised in water management depending on the context, available technology and resources available. Not all command and control instruments have been able to meet the desired target neither have all economic instruments. In the management of water resources there is definitely not a one size fits all when considering instruments, decisions have to be made on a case by case examination. The choice of instruments should depend on the goals and concerns of water manger. In the Caribbean there has been a trend to utilise command and control instruments more than economic instruments and this has been because of the perceived challenges with implementation. To move away from this there is a need for a change of thinking by water managers in the region and for each case to be carefully evaluated to determine which instrument will bring the most efficient results.