Millennium Post

Water conservation dilemma-II

In part two, NIE+ framework is being used to address the myriad of complications that affect the water policies and suggest policy solutions

Continuing on from last time, we move past analysing the global issues plaguing water policies and on to use of the NIE+ framework for the purpose of suggesting possible solutions.

Water policy and NIE+

There is a general consensus that water policy is more a governance issue than anything else (Saleth 2018). Governance means dealing with water institutions: both formal (laws, policies, governance structures etc.) and informal (customs, norms etc.). Water institutions, in any country depend on the level of formalisation of the economy (Shah 2004). In a highly formal market, one would be able to see a high level of metering, pricing of water by market forces, existence of a water regulator to settle disputes and ensure a level playing field and many players as suppliers in the water market. On the other hand, an informal water market would be characterised by self-provision (through private wells, streams, ponds), community-managed water sources, absent or limited use of price or user charges to recover costs of service provision or resource use.

Let us recall North's (1990) definition of institutions as 'formal rules, informal constraints (norms of behavior, conventions, and self-imposed codes of conduct) and the enforcement characteristics of both and also the notion that 'if institutions are the rules of the game, organisations are the players'. We see that there is a great deal of institutional variation in the formal and informal water markets referred to above. Again, let's look at North's distinction between institutional arrangements (IA's) and institutional environment (IE) and apply it to the above discussion. The institutional environment is defined as "the set of fundamental political, social and legal ground rules that establishes the basis for production, exchange and distribution. Rules governing elections, property rights, and the right of contract are examples...'' (Davis and North, 1971). On the other hand, institutional arrangements (IA's), 'are the structure that humans impose on their dealings with each other' (North 1990).

In context of the water sector, when we refer to IE, we mean water policy, water related laws, and the macro environment, etc. The IAs would include all the 'rules in use' and the two together are necessary to understand any institution and institutional change.

Casting this in the NIE+ framework, which includes Coase's approach to transaction costs and the notion of social capital, the formal water market would have low transaction costs of supplying water, which means low implementation, supervising and monitoring costs of supplying water 'ex ante' and low enforcement costs 'ex post'. A formal market would also have a 'formal' institutional structure, including well drafted contracts, an independent regulator to settle disputes, market determined water charges and organised service providers (private, municipal or public). There would be a greater play of the IE as compared to the IA in North's terminology. In such a formal setting, social capital would be less of a factor in reducing transaction costs. An informal market, on the other hand would have high transaction costs and an informal institutional structure rooted in the village community. For example, an informal market would usually not have any written contracts and supervising and monitoring costs will be high since there is no metering. Here the IAs would be more critical as compared to the IE. As for social capital, it would have the same role in formal and informal markets: the role of lowering transaction costs. However, this role would be more critical in the informal markets, where social capital would be more important in making the village community institutions more effective. After all, the village community setting is far smaller than a big formal urban setting and the levels of trust in each other becomes essential if the rules of water usage from community wells, streams and water bodies are to be followed by everyone.

The NIE+ framework gives us the following main policy guidelines:

Those institutions that lower transaction costs on a sustained basis will take root as rules-in-use. However, such institutions may not be the same in a formal and informal market. Further, transaction costs have to be lowered on a sustained basis. For example, if there is an NGO or a leader (say, the well-known Rajendra Singh in India) which brings forth an innovation which reduces transactions costs. This innovation has to be independent of the leader and must continue to reduce transaction costs even if the leader moves on.

What IAs work in a particular IE may not work everywhere. In other words some arrangements such as water use associations in the US, where the macro Institutional Environment (IE) is more mature and evolved, may not work in a developing country where the IE is weak.

The right incentive structure and effective sanctions is important for an IA to succeed in both formal and informal markets

Enforcement of the rules-in-use is extremely important, particularly in the informal market. As North suggests that, "..institutional setting depends on the effectiveness of enforcement. Enforcement is carried out by first party (self-imposed codes of conduct), by second party (retaliation), and/or by a third party (societal sanctions or coercive enforcement by state)." Transaction costs facing an institutional change are determined by the ease of enforcement.

It is clear from the above policy guidelines that there is no single solution for an efficient water supply system. Not only are the contexts different in developing and developed countries, they vary even within the countries. It is also clear that privatisation is neither a solution, nor a preferred policy option even in developed countries. Even in mature markets such as the US and many European countries, the bulk of the water supply, whether for drinking water or for irrigation, is managed and controlled by the public sector. This is possibly because of the uniqueness of the water and sanitation sector as compared to other infrastructure areas such as ports, airports, highways etc. The most obvious unique character is that water is a basic need and water supply has externalities for other significant sectors such as health and environment. These externalities mean that public interest and public welfare is involved and governments must therefore have an important role. Another unique aspect is that multiple agencies and multiple levels of government are involved in the water sector, making it cumbersome for the private sector to navigate. And finally, because of water as a basic need and its public good elements, the profit motive is considered secondary. As a result, the private sector is exposed to a number of risks, including political, contractual, regulatory and foreign-exchange risks, which makes the investment less attractive.


As is clear from the above discussion, most countries have tried to put in place different institutional matrices for the water sector. But, given the complexity of the water sector, no single matrix is perfect and frameworks often remain incomplete. In most countries, the water sector is still characterised by a multiplicity of government agencies at different levels responsible for water supply, management, supervision and control. Some countries have done better than others but challenges remain.

We have also learnt that there is no single solution for the complex challenges that the water sector poses. Privatisation was not a preferred policy option for developing countries for obvious reasons: long gestation lags, low levels of economic development and hence lack of purchasing power and ability to pay market-based tariffs and risks involved in large investments. Most privatisation in water supply in developing countries has been in the PPP mode and the results have been mixed. Interestingly, privatisation was not the first policy choice even in developed countries. To be sure, the US and many countries of Europe encourage private sector participation in water supply, but here again, the results have been mixed.

To conclude, the relevant institutional matrix of a water economy depends on the degree of its formalisation. As discussed above, in informal water economies, the IE has a limited role. As we move from developing to developed economies, the importance of the IE increases. On the other hand, the role of IA and social capital is far more important in developing economies with informal water markets as compared to developed economies. The reason is simple: in formal markets, the institutions and the laws (or the IE) are mature, contracts are complete and the enforcement of contracts is efficient. Since there is little incentive for any party to deviate from the contracts, the transaction costs of getting into contracts 'ex ante' and supervision, monitoring and enforcement of contracts 'ex post' is low. In informal markets, contracts are incomplete and enforcement of contracts is inefficient, as a result of which transaction costs are high. Factors like social capital, which includes trust, customs and norms, play an important role in rule setting and rules-in-use in respect of usage of water, water fees, fines and penalties. Accordingly, common property management is a better way to manage the water resource and a higher level of social capital reduces transaction costs in such settings.

The writer is an IAS officer, working as Principal Resident Commissioner, Government of WB

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