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Economic Instruments for Sustainable Water Management in Water Scarce and Drought Prone Irrigated Areas

Periodic Reporting for period 1 - WATER INCENT (Economic Instruments for Sustainable Water Management in Water Scarce and Drought Prone Irrigated Areas)

Reporting period: 2015-06-01 to 2017-05-31

More than 50% of total water abstractions in Southern Europe come from the agricultural sector, rising to more than 80% in some regions. Water abstractions are particularly high and fast growing in profitable irrigated areas in the Mediterranean Basin, where agricultural demand enters in direct competition with basic environmental services increasingly often. Urgent action is needed to address this unsustainable trade-off. Economic instruments represent a means of adapting demand to collectively agreed goals and thus relief pressure over stressed EU water bodies. In particular, recent water resources research has put forward the role that can be played by agricultural water markets and drought insurance for irrigated agriculture. These two instruments have been already tested (markets) or at least explored (insurance) in a EU context, but it is still unclear what can be expected from them.
Results show that conventional approaches to water scarcity and drought management in selected case study areas is neither efficient nor cost-effective. Relevant economic gains can be obtained from the implementation of markets and drought insurance to reap existent welfare-enhancing opportunities. The research also shows analytically how economic instruments can be developed in the case study areas attending to the institutional and legal setting and potential resistance from those negatively impacted by the reform. In this vein, different alternatives for implementing water policy reforms are assessed (e.g. water markets and buyback).
[WP1] Drought insurance for irrigated agriculture: I have developed and calibrated the Revealed Preferences Models (RPM) to estimate farmers’ Willingness To Pay (WTP). The revealed utility function has served to estimate the trade-offs between expected income and risk aversion and calculate the WTP for insurance coverage using the certainty equivalent concept in the two case study areas, namely the Segura and the Po river basin districts. Two papers have resulted from this exercise, one of them already published in the Journal of Risk Research, and the other one currently under review.

[WP2] Agricultural water markets: I have integrated the RPM in an Agent Based Model (ABM). RPM are used to estimate the utility function of farmers. Each farmer is then placed in an environment developed using the ABM software Netlogo, and exposed to key stimuli (water availability, institutional, legal). Based on their utility functions and conditioned to information networks and past learning processes, agents interact in the model with each other to develop optimal adaptation strategies. The case study area are the interconnected Segura and Tagus river basins. Another type of trading modeled in my research is that happening between private and public agents through water buyback tenders, which is assessed through a case study in the Segura River Basin. Two working papers are currently under review.

[WP3] In the Po River Basin District, drought management does not consider pecuniary exchanges of any type and is based on voluntary agreements among users. Research addressed intermediate solutions that may underpin the development of sophisticated economic instruments in the future. Voluntary agreements among users have been modeled using RPM. RPM have been also used to explore the role that incremental water charging (temporary levies on water use) can play in reducing the environmental costs that arise during drought events. One paper has been published on incremental charges, and another one on voluntary agreements is under review. These papers addressed the coupling of the RPM with a regionally-calibrated Computable General Equilibrium (CGE) model and an Input Output (IO) model to estimate the local and economy-wide impacts of water policies. Results provide a basis for the assessment of the full abatement costs of water conservation.A paper on the role of economic instruments at a basin scale is also under review.

All these research outcomes have been presented in the context of international conferences detailed below:

-Can crop income insurance work: A view from the demand side. Event: ​European Association of Environmental and Resource Economists (EAERE) 22nd Annual Conference, Zurich (Switzerland), 22/06/2016 - 25/06/2016.​
-Coupled mathematical programming and CGE modelling for drought policy assessment. Event: ​Understanding Risk Forum 2016​, Venice (Italy), 18/05/2016-20/05/2016.
Incremental water charging in agriculture. A case study of the Regione Emilia Romagna in Italy. ​Event: ​60th Annual Conference of the Australian Agricultural and Resources Economics Society, Canberra (Australia), 02/02/2016 - 05/02/2016.
​-Water buyback in Spain: what should we expect?​ Event: ​60th Annual Conference of the Australian Agricultural and Resources Economics Society, Canberra (Australia), 02/02/2016 - 05/02/2016.​
-Incremental water charging in agriculture - a case study in the Regione Emilia Romagna (Italy). Event: Society for Risk Analysis World Congress, Singapore (Singapore), 19/07/2015 - 23/07/2015.
-Water charging and water saving in agriculture. Insights from a revealed preference model in a Mediterranean basin. Event: European Association of Environmental and Resource Economists (EAERE) 21st Annual Conference, Helsinki (Finland), 24/06/2015 - 27/06/2015.
Although the instruments assessed in this project have been tested (water markets, water pricing, voluntary agreements) or at least explored (drought insurance) in a EU context, it is still unclear what can be expected from them under alternative settings. The main contribution of my research consists of measuring trade-offs between the environmental and economic performance of these instruments and assessing their contribution to water policy under different scenarios.
This major innovation has been achieved through specific methodological breakthroughs: 1) my work has advanced research on water markets and drought insurance through the use, for the first time in these fields, of RPM. RPM offer a sound theoretical basis and useful numerical results for policy evaluation, thus solving the trade-off typically observed between economic theory and numerical results in conventional simulation models. 2) This is the first time RPM are nested within ABM. By combining them, the theoretical rigor of RPM sets limits on outcomes from ABM, while ABM add realistic behavioral features to RPM. 3) I developed method to estimate the WTP for drought insurance. 4) I coupled micro and macroeconomic models to assess the full abatement cost of overallocation / droughts using a wide array of modeling tools comprising RPM, ABM, CGE and IO. 5) I explored the integration of these methods in hydro-economic models.

This comprehensive research on abatement costs will demand further efforts that complement these outcomes and validate results. It also sets the stage for future research on transaction costs, the missing component of the cost-effectiveness analysis typically used to inform EU water policy.