Using hydro-economic modelling to investigate trade-offs between ecological and economic water management objectives

Abstract

In regions where water scarcity exists, economic analysis can help identify ways to increase benefits of water use. The European Union’s Water Framework Directive (WFD), is an example of a law that requires the use of economic principles, approaches, and instruments in water resources management. One of these instruments is water pricing. This study develops an approach for implementing the water pricing guidelines of the WFD at the river basin scale and then uses hydro-economic modelling to estimate the impacts of applying these guidelines. The central purpose of the WFD is the protection of water resources within the European Union (EU), and water pricing policies are applied with the goal of maximizing economic efficiency while meeting WFD ecological status and groundwater sustainability objectives. The WFD requires member states to implement water pricing policies that provide incentives for efficient use and contribute to the environmental objectives of the directive. This is interpreted as an endorsement of the use of water pricing as a tool to increase the economic efficiency of water use at the river basin scale. It is assumed that a single river basin planning authority exists and is able to implement a policy that can be applied to all wholesale water users that abstract raw water for economic uses. Water users are assumed to respond to water price changes according to microeconomic theory, either as profitmaximizing producers or utility-maximizing consumers. This study investigates two water pricing policies. The first is a single volumetric water price that is applied to all wholesale water users in a case study basin. The volumetric price does not vary in time or space and applies to both surface water and groundwater. The second water pricing policy is the same as the first except that surface water and groundwater are priced differently. Irrigation accounts for almost 90% of total water use in the case study river basin, which is the Aggitis River basin in northern Greece. Because the impacts of water price changes are likely to have a significant impact on irrigation water users, a reasonable model of the economic behavior of irrigation water users is an important element of this study. Two approaches are compared: the residual imputation method and a method based on Positive Mathematical Programming (PMP) that assumes agricultural production can be represented using a functional form that assumes a constant elasticity of substitution between production factors. A hydro-economic modelling approach is used to estimate the impact of water pricing on water use. The approach includes a river basin decision support system; methods for predicting water use as a function of water prices; an approach for measuring welfare changes resulting from water price changes; a method for assessing whether environmental flow requirements have been met; an approach for checking groundwater sustainability; an optimization approach that is used to identify appropriate water prices; and an uncertainty analysis approach. An important conclusion of this study is that water prices would have significant economic impacts on the agriculture sector. These impacts appear to be concentrated on growers of low value crops such as maize, cotton, and fodder crops, which would be unprofitable to grow even at lower water prices. The PMP and residual imputation approaches predict similar changes in irrigation water use as a function of water price changes. Although the PMP approach has the capacity to predict a wider variety of responses to water price changes, these responses are not observed. Despite the fact that the PMP approach predicts that deficit irrigation will be profitable for many high value crops, the approach does not predict that low value crops will be converted to high value crops as prices increase. Because most irrigated areas are allocated to low value crops in the baseline data set, the result is that land and water use levels predicted by the two approaches are essentially the same. The prediction that high-value irrigated crops will not replace low-value crops is not unreasonable given behavior observed in the baseline data set and highlights the limitations of using economic models calibrated to observed behavior to predict responses to new conditions. The second water pricing policy, in which surface water and groundwater are priced differently, shifts a small portion of costs imposed by higher water prices from low value crops to high value crops and from small urban/domestic locations to larger locations. Because growers of low value crops will suffer the most from water price increases, the second policy offers the advantage of reducing this burden.