CAN MARKETS BE USED TO PROTECT THE ENVIRONMENT? THE CASE OF CHILEAN WATER MARKETS- MATTHEW SMYLIE

Image: Alex Perez (Unsplash)

The Chilean water market has been championed as the leading example of free-market approaches to managing water resources, employing the market mechanism to provide incentives that guide agents towards using resources efficiently . This post argues that free-market approaches to environmental protection, in which state regulation is largely absent, are inadequate for the protection of water resources. Chile has experienced many issues in instituting a market for water, facing resistance from local cultures while also suffering from inadequate infrastructure and institutions. Indeed, where the water markets have been active, they have produced economic gains, improving agricultural efficiency and diverting resources towards high-value uses such as mining. Yet, the water markets have been ineffective in protecting the nation’s rivers and aquifers, with profit incentives and a lack of regulatory oversight leading to unsustainable extraction and degradation of water supplies. Indeed, the markets have had negative impacts in terms of social equity too, with peasant farmers as well as urban residents being denied affordable access to water as a result of hoarding and speculation by market actors. Yet, the case study of Chile does not suggest that market approaches are entirely unable to protect water resources; rather, it highlights the fact that markets are insufficient on their own; they require rules, regulations and institutions to ensure their effective functioning.

Protecting the Environment

The environment, broadly defined, is understood simply as our surroundings; both natural and man-made . More specifically, the natural environment has been viewed as comprising of four key spheres; the biosphere, atmosphere, hydrosphere and lithosphere, which interact with one another to maintain the earths functioning . This essay focuses on the protection of the natural environment, specifically upon the safeguarding of water- the key element of the hydrosphere. Water is a crucial resource for ecosystems, allowing plants to grow, providing nutrients to physical life and providing habitats for many organisms . It is also crucial to human survival and progress, allowing humans to stay hydrated, grow food and develop industries. Thus, for the preservation of the earth, and of humankind, the protection of water is of great importance.

In managing common-pool resources such as water, whereby nobody owns the resource and its use is open to all, Hardin predicted that a ‘tragedy of the commons’ would arise. From this perspective, an ever-growing population of rational, self-interested actors would make decisions resulting in catastrophe for water supplies . This is an issue of population growth as well as collective governance; in the absence of regulations and rules, users of rivers and aquifers will withdraw far more than the optimal amount , preventing the source from recharging and leading to the over-exploitation of the water supply. Indeed, the large expansion of the global population during the twentieth century, and the resultant surge in water usage demonstrated in figure 1, has put significant stress on water supplies. Resultantly, a tragedy of the commons appears to be unravelling in which population growth, over-exploitation and poor governance are leading to issues of water scarcity and pollution , as well as conflicts over access. In response, there has been growing consensus among organisations, including the World Bank and the United Nations, that water management must be reformed if we are to avert water crises.

The experience of Chile provides a particularly valuable case to analyse whether markets can be used to protect water. While Chile has a relatively abundant and stable supply of water, this supply is unevenly distributed, with the Capital, Santiago, suffering from droughts in recent times . Chile is also highly reliant on water supplies, with its economy built around the water-intensive industries of agriculture and mining . Efficient governance systems are therefore crucial for Chile, with the efficient use of water crucial to both economic and environmental sustainability.

Further, Chile poses a unique case by virtue of it being the leading example of a market based, laissez-faire approach to water management in which water rights are treated as both private property and as tradeable commodities. Under Pinochet’s military dictatorship, which championed neoliberal economic policies, the 1981 Water Code was introduced to end centralised water management and create private property rights, shifting the costs of water management onto users. This highly laissez-faire approach to water management, in which the state has little involvement and possesses minimal regulatory powers, remains in contemporary Chile. Under this system, the state grants private rights for the use of both ground and surface water; these rights are separate from land ownership and can be freely traded, loaned, transferred and mortgaged. After the state has allocated all rights to water resources, ‘future transfers of water rights are supposed to take place through the market’ . Indeed, the 1981 Water Code is unique in that it does not place any restrictions or regulations on water usage, leaving management entirely to private agents. Resultantly, the Chilean water markets have gained significant attention, often being promoted by the World Bank as a model to be emulated by other nations. Thus, the laissez-faire approach of Chile’s water management systems presents itself as a valuable case in analysing whether markets can be used to protect water resources.

Market Activity

To assess whether Chile’s water markets have been successful in protecting water resources, it is first important to investigate whether such markets exist and to what extent they can operate freely. Academics representing the World Bank suggest that the water markets have been ‘operating effectively with relatively unsophisticated conveyance technology’, granting agents the freedom to trade their water rights, with approximately 600 transactions taking place in the Santiago area alone during 1993-1994 . From these accounts, it appears that Chile has successfully established water markets in which agents are free to trade water rights. However, Bauer argues that these accounts are overly optimistic and have been based upon the potentially bias work of Renato Gazmuri; a key member of the neoliberal government that set up the 1981 Water Code. Indeed, since the publication of these earlier works, academics have argued that Chile’s water markets are relatively inactive, with numerous factors impeding its operation.

Firstly, markets have struggled to take off due to the influences of local cultures, with communities resisting the market logic and seeking to decommodify water. This is the case in the Atacameno community where local people celebrate water as a sacred subject and have reject the idea that water should be treated as a saleable item. Rather, the Atacameno people operate under local customs where there is a close tie between the community and water, with members performing rituals and carefully looking after water resources in order to preserve the community and the environment. The existence of these customs means that the sale of water rights has become akin to committing a crime, with locals, as well as mining companies operating in the area, acknowledging the internal ban on the sale of water. This demonstrates how the market cannot simply be institutionalised; the process of commodifying water and exposing it to the logic of the market has faced strong resistance from communities that value their cultures and traditions.

Further, water markets have been impeded by the fact that water is a highly complex object to commodify. Since ‘water constantly flows and changes its physical condition’, it has been difficult for Chile to formalise private property rights, thus creating uncertainty over who possesses rights to water. Indeed, for water rights and markets to be implemented, sufficient infrastructure is needed to store and transport water. However, Chile suffers from inadequate reservoir and canal systems, making it costly and difficult to store and transport water. This highlights the fact that water is a ‘fictitious commodity’ which requires special arrangements for it to become an economic good that can be traded in markets; in this case, physical infrastructure which would allow users to store and transfer their water at low cost.

Yet, the water markets are further impeded by institutional defects as well as transaction costs. Water rights are poorly defined, with the majority of rights not formally registered and great uncertainty existing over who has access to return flows in river systems . Similarly, the record keeping of rights and the oversight of transfers is deeply uncoordinated, breeding uncertainty and conflicts which further impede the functioning of the market. High transaction costs also impede the market; a lack of public information makes it difficult to find potential buyers and sellers, with many potential market participants relying on newspapers and word of mouth. This highlights the need for strong watchdog institutions to provide information, resolve conflicts and oversee the granting and maintenance of rights in order to allow the water market to function.

These factors demonstrate how, in the case of water, it is highly complicated to create markets in the first place. Sufficient institutions and infrastructure are needed for markets to function, while markets also face strong resistance from local communities who value their traditions. Yet, water markets have taken off in some areas of Chile, particularly in the North and the areas surrounding Santiago where water is scarce and demand is high. The following sections investigate whether these markets have successfully protected Chile’s water resources.

Water Markets in Action

Where active, the Chilean water markets appear to have had positive effects on the economy, as well as on the protection of water resources. The market has allowed farmers to transfer surplus water to cities, saving urban areas from having to try and capture more water for their area in times of drought. Further, transactions have allowed for the reallocation of water resources from low to high value uses, with rights transferred from agriculture to mining. This represents a potential gain in terms of both economic efficiency and growth, allowing Chile’s lucrative mining industry- the nation’s largest employer, contributing an average of 14.9% to Chilean GDP over the last 10 years – the ability to access water.

Further, the water markets have made positive contributions in terms of the efficient use of water in agriculture. Here, water trading has resulted in farmers investing in water-saving irrigation equipment, allowing them to sustain past levels of production whilst using less water, thus relieving pressure on water resources. Indeed, market incentives appear to have been key, with a 30% increase in irrigation efficiency allowing farmers to sell approximately $10,000 worth of water rights without having to scale back production. The result of investment in irrigation technology has been substantial efficiency gains, with a 26% increase in aggregate water use efficiency in agriculture.

Yet, this positive outlook has been challenged, with suggestions that the water markets have failed to protect water resources. Indeed, while the water markets have allowed for economic gains through the transfer of water between sectors, this has resulted in increased water usage. This is because water rights are transferred from agriculture, where water is used seasonally, to mining, where water is used all year round. Similarly, the market allows agents to sell wastewater to mining companies, preventing basins from being able to recharge. Thus, the existence of water markets allows for transactions that lead to overexploitation and the unsustainable use of water resources. Further, while efficiency gains have resulted from investment in irrigation technology by farmers, Bauer reports that irrigation efficiency in Chile remains low, with the small gains made coming as a result of factors other than the market, such as investments to improve crop yields. Thus, while the water markets have provided economic gains, they appear to have performed poorly in terms of protecting water resources.

The idea that the water markets have provided economic benefits while having little impact on the protection of water is reinforced by the case of Chile’s hydroelectric sector. Here, the creation of nonconsumptive water rights, which are key to the functioning of the water market, have encouraged the development of hydroelectric power in Chile. This sector is important to economic growth, accounting for 40% of Chile’s energy supply and filling the gap left by a lack of oil and gas reserves. However, these hydroelectric plants have negative impacts upon rivers and communities, causing droughts while also cultivating excess amounts of algae and reducing local farmers access to water. Indeed, hydroelectricity also affects the wider environment through the production of harmful carbon emissions which contribute to the issue of global warming. Thus, the creation of private water rights and water markets have allowed for the development of industries but have also created challenges for the protection of water resources.

Further, the existence of the water market has created incentives for agents which serve to deplete water resources. In the search of profit, owners of water rights purposely divert water into the ocean in order to create scarcity and sell their water at a higher price. This leads to a reduction in the water supply and reduces peoples access to water resources. Indeed, the water market also creates perverse incentives for people in the La Ligua and Petorca Valleys of central Chile. Here, the limited availability of water rights means that their market value high, thus creating an incentive for people to falsify water rights in order to make substantial profits. Resultantly, the market for water contributes to the issue of illegal extraction of water in Chile which sits at approximately 1,000 litres per second per year and contributes to the rapid depletion of aquifers and rivers. This highlights the need for effective watchdog institutions to monitor the use of water markets in order to ensure the protection of water resources.

Indeed, the highly laissez-faire nature of Chile’s water markets, in which regulation and state oversight is largely absent, has contributed to water resource being poorly managed. From the outset, inadequate definitions of water rights have resulted in the overexploitation and degradation of water resources when rights have been transferred. Further, little effort was put in to determine the limits on how much water should be used and how many rights should be granted. Indeed, despite the DGA- the body responsible for regulating Chile’s water markets- knowing the recharge rates for the nation’s aquifers, it has allowed for overconsumption of groundwater resources consistently since 1985, thus preventing the aquifers from recharging. As a result of minimal regulatory oversight, large companies have been able to appropriate huge amounts of rights to water, leading to the overexploitation of water resources while the DGA have failed to adjust limits to bring down usage to a sustainable level. Thus, the absence of state involvement appears to have let the market take over, leading to the over-extraction and destruction of Chile’s water resources.

Market Failure?

The previous section demonstrated that while producing economic gains, the Chilean water markets have been inadequate in protecting the nations water resources; this is confirmed in observations and empirical studies, focusing on both water the quantity and quality of water in Chile. In the city of Copiapó, over-extraction of groundwater resources has resulted in the complete drying up of local wells, with citizens now relying on wells located closer to the coast which produce saltier, harder water. Similarly, the 12 square kilometre Aculeo Lake near Santiago has run dry as a result of both climate change and over-extraction by farmers; this has led to the death of local wildlife as well as the local tourism industry. More generally, water availability continues to fall across the country, most notably in Santiago where water availability is predicted to be 40% lower by 2070. Indeed, many Chileans are dissatisfied with the quality of their local water supplies; only 69% indicated that they were satisfied making Chile one of the poorest performers in the OECD.

Yet, not only have the water markets been inadequate in protecting water resources, they have also had important distributional impacts for Chilean society. There has been a tendency for corporations and large farmers to hoard water rights since there were no rules or punishments for the non-use of water rights. Further, many businesses have engaged in speculative activity, buying up excessive amounts of water rights and refusing to sell them in the hope that their value will increase, bringing substantial profits. Similarly, there have been issues with monopoly control over water resources, with some power-generating companies acquiring the rights for entire rivers.

Indeed, the distributional effects of hoarding, speculation and monopoly power in the water market has been considerable. Peasant farmers have been particularly affected, with high prices making access to water unaffordable while large farming companies have appropriated the vast majority of available water rights. Yet, it is not only the rural peasant farmers who have experienced negative impacts on their livelihoods; millions in Santiago are affected by extortionate prices and a lack of access to water as a result of monopoly power. Resultantly, the water market has worsened income inequality in Chile while also making it harder for citizens to access water.

These issues illuminate the broader debate of whether a system of private property rights and markets is appropriate for the management of water. Many argue that such a system is not suitable, arguing that access to clean water should be recognised as a human right. From this perspective, water should not be marketized because it is a scarce resource that is essential to human existence, with the right to water implicit in other basic rights such as the right to food and life. As such, the state should manage water resources in accordance with ideas of equity and justice in order to guarantee water for all, rather than allowing commercial motives to control such a vital resource. Yet, opponents of this idea argue that the granting of such a right would have little impact in terms of access to water, while also challenging the anthropocentric approach of human right activists on the basis that a human right to water could infringe upon ecological rights by further degrading water resources. Indeed, a human rights approach to water does not imply that water should be free or that it should not be allocated through markets, rather, it highlights the need for safety nets, possibly in the form of subsidies for the poorest in society, which guarantee all citizens access to affordable water.

As a result of the damage done to water resources and to wider Chilean society, as many as 74% of Chileans want the management of water to be renationalised. Indeed, Bachelet’s socialist government had sought to adopt a new institutional framework that would see the state control water rights. Yet, the issues discussed in the preceding analysis do not suggest that markets are incapable of protecting water resources. Rather, the Chilean experience highlights the fact that ‘market solutions do not mean automatic and self-maintained solutions’ rather, markets require strong regulatory institutions to ensure their functioning and success. As such, effective systems of water resource protection do not necessitate the abolishment of markets; they require policymakers to recognise the limits of the market and build institutions that improve outcomes. For Chile, and those seeking to emulate their market approach to water management, this would involve tighter regulatory oversight to address the issues of over-extraction, illegal activity and social inequity discussed in the preceding analysis. More broadly, education, public information and databases on water supplies are needed to ensure the sustainable use of water resources. Indeed, Chile has taken steps to improve the functioning of the market, introducing reforms in 2005 to address the issues of speculation and hoarding through limitations on non-use although greater reforms are needed to avert future water crises.

Conclusion

This post has investigated, through a case study of Chile’s water markets, the idea that markets can be used to protect the environment. Since its inception in 1981, the Chilean Water Code has sought to introduce a market-based system of water resource management, in which agents trade rights to water resources with minimal state regulation or oversight. Indeed, this resembles a market-environmentalist approach in which a market-based system is used to harness peoples self-interest towards the efficient and sustainable use of resources in order to protect the environment. However, in practice, the highly laissez-faire approach used by Chile has failed on numerous counts. Firstly, markets have been impeded, facing resistance from local cultures, while also facing issues in terms of institutions and physical infrastructure, reflecting the difficulty of commodifying water. This highlights the fact that market logic cannot simply be instilled; markets are complicated systems to establish.

To the extent that water markets do operate in Chile, they have provided important economic benefits, improving efficiency in agriculture and allowing water to be transferred to high-value uses, such as mining. Yet, the market has failed to provide adequate protection for water resources. Indeed, the market has created incentives for agents to divert water into the oceans, to falsify water rights, to transfer water to mining operations and to develop hydroelectric plants. At the same time, a lack of regulatory oversight has meant that water is being extracted at a rate which prevents water resources from recharging. These factors have contributed to the degradation and overexploitation of Chile’s surface and groundwater resources, with aquifers and lakes drying up and citizens finding it increasingly difficult to access good quality water. Further, the water markets have also produced negative social impacts, with hoarding and speculation of rights making water both inaccessible and unaffordable for many in society.

Thus, Chile’s free-market approach to water management appears to have been entirely inadequate in protecting the nations water resources, while also creating social inequities. Yet, this is not to say that markets cannot be used to protect the environment, rather it highlights the point that self-regulating markets are inadequate when used in isolation. As such, regulations, rules and institutions must be in place to ensure that markets can both function and produce positive outcomes. Here, states need to play a more active role in fostering the market environment, providing information, infrastructure and institutions to facilitate market transactions. Further, state-imposed rules and regulations are needed to ensure that market actors act in a sustainable way, carefully monitoring the total amount of water to be used, while also preventing issues of illegal extraction, diversion of water and the creation of industries that degrade the environment. Finally, institutions are needed to ensure that everyone has access to affordable, quality, water with safety nets and limits on non-use being particularly important in the Chilean case.

By: Matthew Smylie

Matthew Smylie holds an MA in International Political Economy from the University of Warwick and a bachelors degree in Politics, Philosophy and Economics from Warwick. He is incredibly passionate about IPE issues..Matthew runs he’s own website The Political Economist, check it out :https://www.thepoliticaleconomist.co.uk

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