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CHAPTER 5: ECONOMIC ASPECTS OF EUTROPHICATION

5.2. Allocation of Water Resources and Eutrophication

5.2.1. Private and Social Interests

Market structures influence the allocation of resources among competing users. The market allows for the discovery of prices, which provide participants with information about the relative scarcity of a resource. The supply of water in most countries is a monopoly due to the large capita costs required for collection delivery. However, once established it is possible to determine a mechanism that delivers or allocates the water the user that will extract the highest economic return for the resource, This is the role of a market place.

The most referred to market condition is "perfect competition". Under conditions of perfect competition there is full information, no negative external effects from production and market clears for all goods. The perfect competition model is well known and is not necessary to repeat here its determining conditions. The allocation of production factors, such as labour, capital and natural resources (land), among alternative uses, as a result of market mechanism, will provide maximum social welfare. All these conditions rarely exist in the real world. Consequently, imperfect competition prevails and discrepancies of a variable degree between private and social interests should be expected. However, imperfect markets can be improved with economic instruments and efficiency should be pursued.

In summary, one or more of the following elements may be the origin of imperfect competition and of discrepancies between private and social interests: externalities; public goods; social or communal ownership of certain resources, or ambiguous property rights or absence of any rights at all; distributive inequalities; monopolistic conditions; the lack or weakness of markets for certain environmental goods; government induced distortions through taxes, subsidies and price fixation; and information failures. Externalities are variously known as external effects, external economies and diseconomies, spillovers and neighbourhood effects. Externalities involve an interdependence of utility and/or production functions; they represent the beneficial or adverse effects resulting from activities of one firm or household on the activities of another firm or household. A negative externality or diseconomy represents certain costs caused by an activity which are not perceived as such by the firm who is causing them. However, they do have effects on other activities and agents or on society as a whole. Backward linkages of eutrophication are the source of an externality and forward linkages are the areas the externality influences. In most cases, eutrophication is linked to production decisions of water users. These are referred to as production externalities. A feature of a production externality is that there are goods that people care about, but they are not sold on markets. The lack of markets for externalities causes problems. Considering the permanent confusion among concepts on public goods and common property goods, it seems appropriate to clarify both. A public good is a commodity or service, which, if supplied to one person, can be made available to others at no extra cost. Improving this definition, it should be said that public goods are non-excludable or non-exclusive and non-rival. Non-excludability means that individuals who have not paid for a good cannot be prevented from enjoying its benefits. For example, everyone benefits from a clean lake whether they have contributed to the restoration programme or not. If a good is non-rival, its consumption by one person does not preclude its enjoyment by anyone else. In the case of a lake, one person can enjoy the view of the clean lake without limiting the enjoyment of anyone else, up to certain degree (e.g., extreme overcrowding could limit the view of the lake).

Three categories of failures were defined, which induce under-valuation of environmental assets: institutional failures (as externalities), market failures (as the absence or ambiguity of property or user rights) and policy failures (as some distorting subsidies). The direct results of this situation is that firms and households do not receive appropriate signals which would induce them to internalise the real scarcity of the resources they use and the costs of the environmental deterioration they could cause. The decisions of social actors would determine a "socially wrong" combination of the national product with an excess of production and consumption of goods. This leads to exhaustion or deterioration of natural resources and to pollution, in contrast to a low production and consumption of goods, which could favour conservation and avoid pollution. This, in turn, induces economic valuation of environment resources and functions, and optimisation criteria, which are a determinant in the activities economic agents eventually develop provoking negative environmental impacts. These concepts do not ignore the incidence that some factors may have in the decisions of social actors, such as public awareness and individual ethical considerations, with respect to environmental damage and conservation.

Externalities are a good indicator of market failure. Whenever externalities are present, the resource allocation provided by the market may not be efficient. Since individuals do not bear the full cost of the negative externality they generate, they will engage in an excessive amount of such activities.

Economic policies can be used to internalise or correct market failure. It is the role of government to determine the most cost-effective solution that corrects the externality. There is a widespread belief that without government intervention the pollution level would be to high. Government can provide regulation (for example, emission standards, or regulate water use) or use the price system (for example, penalties or fines can be imposed on the negative externality) to achieve an efficient resource allocation. Others forms of market failure, as discussed above, include pure public goods (i.e., incomplete markets), failure of competition and information failures. Information failures are usually motivated by the imperfect knowledge of consumers. The belief is that the market by itself will not supply sufficient information. Notable applications include the loan market and asset sales. Governments may not have a direct role in regulating firms to provide information but they can educate the consumer thus promoting inquiry by the consumer.

For many authors markets can be efficient resource allocation mechanisms among alternative uses through time. Nevertheless, certain conditions should be met. In case they are not met, the market would be unable to guarantee an efficient resource allocation. Most of environmental problems associated to management or to an inefficient use of natural resources can be attributed to malfunctioning of their markets, to distortions or to a total absence of a market. Prices under these conditions do not reflect the related real social costs and benefits, and produce wrong signals or confusing information on there relative scarcity, and do not offer adequate incentives to management, and rational use, and conservation of natural resources.

However, the verification of discrepancies between private and social interests is not sufficient to justify government intervention. It has been sustained that, although market limited capacity to allocate and guarantee an efficient use of natural resources and the environment could be a necessary condition to justify intervention, it is not a sufficient condition. To justify intervention two other conditions should be met. The first one is that intervention should be conducive to an improved situation as compared to that being modified. The second condition is that benefits that could be attributed to the intervention should exceed the costs of planning, implementing and enforcing the instrument of intervention, as well as any other indirect cost associated to the distortions that could affect other sectors of the economy.

The presence of market failures does not imply that a particular government program, aimed at correcting the market failure, is desirable. Alternative government programs should be scrutinised and undergo a process of evaluation, basically a cost-benefit analysis.

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