EXTERNALITIES, WATER PRICES, AND WATER TRANSFERS

JOURNAL OF THE AMERICAN WATER RESOURCES ASSOCIATION.VOL. 35, NO.5 AMERICAN WATER RESOURCES ASSOCIATION OCTOBER 1999

EXTERNALITIES, WATER PRICES, AND WATER TRANSFERS'

Jeffrey L. Jordan2

ABSTRACT: Discussing, estimating or analyzing the value of wateris a difficult task. In addressing the value of water as reflected inits price — either as charged by a water utility, as the price of awater transfer, or a water sale in some market — this paper willexamine three propositions regarding water pricing. The paper willconsider the marginal scarcity rent of water, estimates of externali-ties, the full cost pricing of water and the consequences of theseconsiderations on water prices, transfers and the efficiency of wateruse.(KEY TERMS: full cost pricing; efficiency; transfers; economics.)

INTRODUCTION

The focus of water management in the U.S. ischanging from reclamation to reallocation. Both theBureau of Reclamation and the US Army Corps ofEngineers are focusing on improved management ofwater resources rather than simply supply projects.Water policy that affects the reallocation of water willincreasingly occur through the use of water marketsand the inter-basin transfers of water.

In fact, transfers of water in the western U.S. arecommonplace. In just the Colorado-Big Thompsonproject, water has been traded between agricultureand urban water users since the earlyl96os.Michelsen (1994) notes that between 1970 and 1993,there were 2,698 transactions through which morethan one-third of the project water changed owner-ship or type of use. However, Michelsen (1994) alsonotes that although individual transfers occur inmany areas outside of the C-BT project, regular trans-actions, rather than sporadic individual transfers,have been slow to develop and are few in number.

However accomplished, reallocation will be con-cerned with, and affected by, how water is priced andthe values and extent of any inter-basin transfer ofwater resources. Consequently, it is necessary tounderstand the issues involved in pricing and valuinginter-basin transfers of water resources. In address-ing the value of water as reflected in prices, the fol-lowing three points should be considered.

1. The price of water should include the marginalscarcity rent of the resource.

2. The price of water should also include estimatesof the externality effects (both positive and negative)of the use of the resource. The full cost pricing ofwater should include the third party effects whenwater is transferred across basins.

3. Actual compensation should be paid in anywater transfer to ensure an improvement in efficien-cy.

The notion of marginal scarcity rent takes intoaccount both the cost of extraction of a resource andthe user cost that is affected by scarcity. Water pricesnormally include only the marginal extraction cost.However, the real price of the resource is above theextraction cost due to the existence of a marginal usercost. Tietenberg (1992:33-34) uses a water example toexplain marginal user cost. As he notes, using largeamounts of water to keep grass green may be appro-priate for an area with large replenishable water sup-plies, but not when it denies drinking water to futuregenerations. If prices do not take this higher scarcityvalue into account, an inefficiency is imposed on thefuture — too much water is consumed today. This

1Paper No. 98123 of the Journal of the American Water Resources Association. Discussions are open until June 1, 2000.2Professor, Department of Agricultural and Applied Economics, Georgia Experiment Station, University of Georgia, Griffin, Georgia

30223-1797 (E-Mail: [email protected].

JOURNAL OF THE AMERICAN WATER RESOURCES ASSOCIATION 1007 JAWRA

added marginal value that scarcity imposes is themarginal user cost.

Historically, the pricing of water around the worldhas rarely fostered environmentally, economically, orsocially sound utilization of water resources. Ratescharged to public water users are generally basedonly on the costs of producing and distributing water(extraction costs) and not on the value of the resourceitself. Thus, water is treated as an economically inex-pensive commodity. 'While pricing varies across thecountry, it has traditionally followed standard utilitypricing schemes for a firm-controllable flow commodi-ty. In such cases, there is sequential use of units, notransfers spatially or temporally, high fixed costs withlow variable costs, and usually a two-part rate struc-ture made up of a minimum fixed charge and a usecharge.

The central policy prescription of microeconomics isthe equating of price and marginal cost. Marginal costis the cost of producing one more unit, or the addedcost of incremental output. Thus, marginal cost pric-ing has to do with the future, not past, cost of water.At any given time, the economy has a fixed bundle ofresources so the basic economic problem is choice. Ifsociety produces one thing, it foregoes producingsomething else. The cost to society of producing any-thing is the good that must be sacrificed — or theopportunity cost. If people are to make the bestchoice, prices must accurately reflect opportunitycosts. So the price the consumer has to pay mustreflect the cost of supplying more of the good — themarginal opportunity cost.

As Moncur and Fok (1993) note, three majorsources of mispricing arise from standard accountingpractices often used in pricing water. Each of thesepricing practices can lead to the underpricing of waterand consequently to inefficient consumption.

1. The use of actual historical cost data rather thancurrent replacement cost.

2. Failure to incorporate the economic cost of someassets in the rate base. While operating costs areoften accounted for, capital costs are accumulations ofyearly value and are often left out of the rate base.Rates need to account for capital replacement costs incurrent dollars.

3. Failure to include a scarcity premium reflectingthe value of water in situ.

EXTERNALITIES

In addition to the consideration of the cost of wateras a commodity, the value of water must also includethe externality effects of using the resource. In the

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case of water, externalities are defined as costs (orbenefits) that relate to providing water service but areexternal to the supplier and are not included in thecost (or benefits) of service (Raftelis, 1993). This defi-nition includes the basic nature of an externality —that a firm is using resources for which it does notpay or conveys benefits for which it is not compensat-ed. "Internalizing" the externality occurs when awater supplier accounts for — and includes in its costof service — the externality. The Clean Air Act forcedthe electric power sector to adopt compliance tech-nologies, thus reducing the level of externalities. Incontrast, the Safe Drinking Water Act did not producethe same effect because the contaminants at issue areoften not the direct result of the provision of waterservice. Including externalities will influence theselection of new water resources, the extension ofexisting supply sources, and water costs and prices.

The need to address externality issues in waterproject evaluation is the logical result of applying ben-efit-cost analysis. All costs and benefits, includingexternalities, must be considered and, when possible,quantified to accurately conduct a benefit-cost analy-sis of water projects.

The classic example of an environmental externali-ty is pollution. An industry that dumps waste into ariver is using a resource (the river) in its productionprocess. Without the existence of the river, the firmwould have to pay to find an alternative waste dispos-al technique. Because the firm uses the river withoutpaying for its use, the total costs of the productionprocess are not reflected. That a cost exists is clear;however, it is not reflected in the production processof the firm. Someone or something (e.g., fish andwildlife or downstream users) is paying the cost. Theissue is to internalize the cost of the externality toreflect the actual cost to society of the production pro-cess to make the producer of the externality bear itscost. Similarly, it is necessary to account for externalbenefits.

It is possible to identify many external costs andbenefits. They include pollution, occupational risk,and health and safety effects. Benefits external toproduction processes include employment effects,national security, competitiveness, improved livingstandards, productivity, and economics growth(Schmid, 1989). Externalities related to waterresources include effects on the quality of the estuaryand river, effects on supply sources, aesthetics, odors,air quality, recreation, wildlife, jobs, and energy sav-ings (Raftelis, 1993). Externalities may differ whetherthe supply source is surface water or ground water.Externalities associated with surface water tend tohave more immediate effects (such as pollutionor source adequacy), whereas ground water externali-ties also affect allocations across time. Externalities

JAWRA 1008 JOURNAL OF THE AMERICAN WATER RESOURCES ASSOCIATION

Externalities, Water Prices, and Water Transfers

associated with the water process are somewhat com-plex because many environmental compliance costsare, in effect, the externalities of firms other than thewater supplier. In introducing externalities, it isimportant to distinguish between technical or physi-cal externalities (like pollution or reduced reservoirlevels which reduce recreational opportunities) andwhat are called pecuniary externalities. Pecuniaryexternalities occur when external effects are trans-mitted through higher prices (Tietenberg, 1992). Suchcharges may represent a change in the distribution ofincome but including them in the analysis of external-ities would represent double counting (Sassone andSchaffer, 1978).

In the case of a typical negative water externality,the producer pays nothing for the use of the resource.An inefficiently large quantity of water (from a river,for example) is used because the producer does notface a price for the use of the river resource thatreflects, like other prices, the river's value in alterna-tive uses. This inefficiency arises largely because noone owns the river, and its use is free. In fact, thesource of externalities is often found in the absence offully defined property rights: if someone owned theriver, the owner would charge for its use. Randall(1972, 1983, 1987) argues that non-rivalry and non-exclusiveness of some goods results in inefficiency.Non-exclusiveness is an attenuation of propertyrights: if once a good is provided, the provider cannotexclude consumption (the free-rider problem), it isimpossible to collect a price for use. Non-rivalry con-cerns a good that, once provided, is available to allconsumers: one persons consumption of clean air doesnot reduce the amount of clean air available to thenext person.

This problem of externalities has led to effortsto either (1) create a market where none exists, or(2) find ways to simulate the prices for scarce waterresources. The literature on tradeable permitsexplores ways to create markets. The secondapproach, simulating prices, has led to efforts to findways to internalize externalities. In both cases, theconsideration of externalities involves not an issue ofwhether, but of when and how environmental factorswill be addressed.

Figure 1 shows a standard example of externalitiesusing a firm's supply and demand curves. Here thefirm is producing Q1 of its good at a price of P1. How-ever, the firm is using an adjacent stream to dis-charge its waste and not paying for the resource. Ifthe firm had to pay for waste disposal, its productioncosts would increase as represented by a shift in itssupply curve from S1 to S2. At this equilibrium, thefirm would reduce production of its product to Q2andraise its price to P2, internalizing the cost of an exter-nality. While seldom used in practice, governments

can use a tax, equal to P2-P1 to force a firm to pay anamount equal to the cost that the firm is imposing onsociety. More often fines are assessed or regulationsimposed that reduce, if not fully internalize, the levelof the externality. Without action, the firm is produc-ing too much of its good (at Q1) consuming too muchof the water resource in its production process andconsumers are paying too little (at P1) given the envi-ronmental damage being inflicted. This misallocationof resources is the essence of the externality problem.

Similarly, Figure 2 demonstrates a misallocation ofresources when society does not pay for the benefitsproduced external to a firm's production process.Again, without internalizing the benefits in a produc-tion process, the firm would produce at Qi and P1. Ifthe production process produces a benefit that is notpaid for (for example recreation opportunities on areservoir) the real supply curve would be S2. The firmwould produce at Q2 and the price of the good wouldfall to P2. Thus, the existence of a positive externalitymeans that the firm is producing too little at too higha price — another misallocation of resources. One wayto deal with this problem is to provide a subsidy equalto P1-P2.


S2Si

P2P1

0 Q2Q1DQ

Fignre 1. Negative Externality — Firm.

S2$

P1

P2

0D

Q1Q2 QFigure 2. Positive Externality — Firm.

EXTERNALITIES IN WATERPRICING AND TRANSFERS

Jordan

When Mark Twain wrote "whiskey is for drinkin'and water is for fightin' " he must have had in mindthe transfer of water from one basin to another. Inalmost all cases, such transfers involve a disputebetween those in the basin-of-origin and the receivingarea over the issue of compensation. How much is thewater worth? What costs are incurred in the basin-of-origin? Are all the effects of the transfer being consid-ered? Are there indirect costs that should be paid?

There are four broad mechanisms for resolvingwater disputes: legislation, litigation, water markets,and negotiation/mediation. These mechanisms are notmutually exclusive. The resolution of conflicts overwater transfers usually requires the application ofmore than one technique.

While legislation and litigation are more commonand negotiation/mediation is often a localized proce-dure, water markets conceptually can both resolveconflicts (by establishing a price that is agreeable toall parties) and provide for efficiency (by determiningthe highest and best resource use by incorporating allcosts) in the transfer of water. There are five prereq-uisites for an effective system of marketing water:

1. Water rights must be clearly established; theremust be clear title to the water to be transferred.Further, a mechanism should be in place to providean equitable initial allocation of the water rights(title).

2. The water right to be transferred must be quan-tifiable; a system of measurement is necessary.

3. An institutional system must be in place toadminister water rights, requiring record keeping andfair and reliable administration.

4. The infrastructure must exist, or be feasible, tomove water between buyer and seller.

5. The marketing system should provide an effi-cient transfer of water by including externality issues.

The last prerequisite implies that third-partyimplications of the water transfer must be considered.Third parties are those beyond the buyer and seller,who are affected by a water transfer but have no voicein the decision. For a market system to work, the realcosts and benefits to buyer, seller and third partiesshould be included as part of the transaction. Poten-tial external effects that have been identified in previ-ous work on the use of water markets in Texas, forexample, are return flow externalities, instreamvalues, and secondary economic effects (Griffinand Boadu, 1992). Failure to take all these costs into

account will result in diseconomies within the mar-ket, resulting in an inefficient solution.

In looking at the full costs of a water transfer, twobasic economic principles should guide the pricing ofwater:

1. All purchasers of water should bear such addi-tional costs, and only such costs, as are imposed onthe economy by the provision of the additional unit ofwater. Water prices should reflect all the marginalcosts of production and consumption, both those bornedirectly by producers and users, and those costsimposed externally.

2. Short-run marginal cost should always be usedwhen capacity is not fully utilized since it reflects thesocial opportunity cost of providing additional units atthe time of the buying decision. However, as fullcapacity utilization occurs, long-run marginal costmust be considered. Long-run marginal costs includethe cost of increasing capacity to accommodate addi-tional demand.

Au achievable version of marginal cost is pricing at"full cost." Full cost pricing is a concept that is partic-ularly applicable to water markets, but also has aplace in discussion of the allocation of publicresources by any means. The idea of the full price ofwater is derived from the theory of externalitieswhere the external — including third party — effects ofa transaction should be considered. Including thirdparty effects encompasses both notions of fairness andof ownership. In the arena of water supply planning,these notions come to the forefront especially whenconsidering transfers of water or of water rights. Inmany parts of the country, regardless of water rightsdoctrine, surface waters are owned by the State andindividuals or organizations are granted water rightsto permit diversion and use of the state's waters. Topromote economic well-being, State's also participatein development projects to store or convey water foruse. At the same time, State's act as trustee for theprotection of wildlife and habitat that are commonproperty resources of the public. All of these roles givethe general citizenry some ownership — or a "stake" —in the outcome of decisions about the use of water.

Those who live within a river basin often take aproprietary interest in the water resources of thatbasin. Basin residents also have a particular concernabout the impacts resulting from changes in thewater resources within the watershed. In the mostsimple case, water transfer decisions are made by twoparties — the buyer and the seller or the permitterand the permittee. Basin residents or others in thegeneral public who have a particular interest, such asenvironmental or economic development concerns, are



not usually involved in the decision. The true marketvalue of water must reflect all economic costs for themost efficient allocation to occur. These costs shouldbe the result of a technical or physical externality,and not as noted earlier, a pecuniary externality.

For an optimal transfer of water, two conditions arenecessary.

1. The transfer must be the least cost alternative.2. The benefits must exceed the losses to the area

of origin including downstream basins plus transferrelated costs as well as operation and maintenance ofthe movement of water.

This can be further seen using Howe and Easter's(1971) discussion of the necessary conditions for eco-nomically efficient interbasin transfers:

(DBm + SBm) + (DB + SB) > (DCi + SC)

+SC+TC

TC + [DCi + SC) - (DBt + SBt)]> TCa

where DB direct benefits from the actual use ofwater; DC = costs of giving up the direct use of water;SB, SC = secondary benefits and costs in market-related activities as seen from a national viewpoint;TC = costs of the physical transfer system; Ta = cost ofthe best alternative; x =parties in exporting region; m= importing region; t = affected parties in regionthrough which the transferred waters pass; c = par-ties in regions where output is competitive with thoseof the water importing region.

Thus, Equation (1) says that marginal net incomesin the importing and transfer regions must exceed theloss of income in the exporting region and otheraffected regions plus the cost of the physical transfer.Equation (2) says the cost of the physical transfermust be less than the next best alternative. Herethen, in Equation (1), Howe and Easter recognize themarket-related affects a transfer would have on thirdparties in the basin-of-region as well as others affect-ed by the transfer. Secondary costs, however, aredefined as decreases in net incomes of factors of pro-duction or activities that are displaced by the trans-fer. We can extend the Howe and Easter formula toinclude externalities that may occur in a water trans-fer. Thus, to arrive at the least cost alternative, allcosts must be examined, including basin-of-origincosts. These should include the real costs of foregonefuture uses in the basin-of-origin, as well as environ-mental and social costs.

What this formulation implies is that actual com-pensation should be paid in a water transfer. Suggest-ing such actual compensation goes beyond the usual

principle employed in benefit cost analysis. If benefitsand costs accrue to different people with differentincomes and preferences, a water transfer makes animprovement only if the gainers compensate thelosers. Economists refer to this as the Pareto-bettercompensation test (Schmid, 1989:10). Given the costsof compensation, it has been observed that few policyactions could satisfy this compensation test. A differ-ent test, the potential Pareto — better compensationtest, has become the main principle of benefit costanalysis (Randall, 1987). Here, it is suggested that awater transfer would be regarded as improving wel-fare if gainers have the capacity to compensate thelosers, even if this is not actually done. Thus if thesum of gains exceeds the sum of losses, the transferwould pass the test for conventional economic efficien-cy.

If compensation is paid, a Pareto-better situationexists and efficiency increases. However, as Randallnotes, if compensation is not systematically paid,

(1) there is no assurance that a potential Pareto-improve-ment will actually improve efficiency (Randall,

(2) 1987:255). Consequently, only a Pareto-better transfercan ensure an improvement in efficiency.

This full cost of a transfer should incorporate waterquality, instream flows, future uses and other publicinterest values as well as the costs of purchase, trans-mission, operating and maintenance. Includingthird-party effects means that procedures must beestablished to identify and value the impacts of atransfer. The lack of such procedures has made thepotential-Pareto improvement principle the bestchoice in benefit-cost analysis. However, it is possibleto design procedures to include third party effects andthus move to a Pareto-better situation, thus improv-ing the efficiency of transfers. From previous watertransfers, a number of typical kinds of third partyinterests have been identified, including agricultureand rural communities; ethnic communities and Indi-an tribes; environmental interests, urban interests,federal taxpayers, and other water rights holders(National Research Council, 1992). These affectedparties should be brought into the bargaining processor compensated as appropriate once a transfer hasoccurred. Then, only transfers for which social bene-fits exceed social costs would be undertaken, produc-ing an efficient distribution of resources. Thepayment of actual compensation may appear to be anunrealistic requirement given the number of winnersand losers involved in any transfer, and the rent seek-ing which would accompany a desire to compensateall losers. However, as in the following case in south-east Texas, bringing in stakeholder groups to theregional planning process may increase the costs of atransfer increase, but may not make it impossible.


WATER TRANSFERS IN SOUTHEAST TEXAS

A proposed transfer of water in southeast Texasprovides a setting for looking at issues of third partyeffects and compensation. Demand projections for thecity of Houston (San Jacinto, Trinity, and Brazo Riverbasins) indicated a need for additional water by theyear 2050. The lower Sabine basin and specifically theToledo Bend Reservoir in the Beaumont/Port Arthur!Orange area of southeast Texas has been projected tohave supplies of water not needed through 2050. Aninterbasin transfer of between 300 million gallons perday (mgd) and 600 mgd from the Sabine basin toHouston (and San Antonio) has been proposed. TheSabine River and Lake form the border betweenTexas and Louisiana. The Sabine River compact pro-vides that water is owned equally by both states.

A relationship between the buyer (Houston) andseller (Sabine River Authority) was established and awater transfer was possible. However, through a pub-lic input process, residents of the basin-of-originraised a number of concerns regarding the transfer.The two main issues were the potential economic con-sequences of the transfer to future growth in the areaand environmental impacts to Sabine Lake. While theSabine empties into the Gulf of Mexico, the environ-mental water needs of the bays and estuaries had notbeen quantified, and were not included in waterdemand calculations. Only minimum flows for main-tenance of instream water quality were considered.Environmental concerns that have been raisedregarding the transfer include freshwater flows to theLouisiana marshes (including a federal wildliferefuge) on the eastern shore of Sabine Lake. Besidesthe environmental issues, interest groups in theBeaumontiPort Arthur/Orange area see "excess" sup-plies as both a commodity for which compensationshould be paid in a transfer and an economic asset forthe future.

A Technical Advisory Committee of about 50 repre-sentatives of parties interested in water planningidentified a number of third party interests expectedin the potential water transfer (Jordan et al., 1998).

• Local governments (as representatives of basinresidents, as proponents of basin economic develop-ment, as protectors of local quality of life).

• Chambers of commerce and economic develop-ment organizations (with concerns about water as anasset to attract growth and business)

• Environmental groups, State and Federal natu-ral resource agencies, sport and commercial fishers(with concerns about instream flows, inflows toSabine Lake, fresh water for coastal marshes, effectson water quality).

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• Agricultural interests (with concerns aboutbeing "out-bid" for water).

• Recreation fishers and marinas around ToledoBend Reservoir (with concerns about water levels inthe Reservoir).

• State of Louisiana (with concerns about freshwater to Louisiana marshes and concerns about con-tinued availability of water for use by communitiesand industry in Louisiana).

• Federal government (with concerns aboutany transfer route that might affect the Big ThicketNational Preserve or national forests or wildliferefuges).

From this effort, a Southeast Texas Equity TaskForce identified a number for forms of compensationfor a water transfer. These included funding a NechesSalt Water Barrier (the Neches River provides inflowto Sabine Lake), a flood control/recreation/water sup-ply reservoir and other wastewater projects. Othersuggestions included funding previously plannedreservoirs in the Neches and Sabine basins. Non-water related compensation focused on efforts toinduce growth in water-rich areas, a joint air pollu-tion control planning and implementation process,and a joint Houston-Sabine area economic develop-ment marketing program.

In 1997, the Texas legislature created a regionalwater planning process that recognized third partyinterests in water planning and mandated a balanc-ing of interests in interbasin transfers. The legislationalso provided that interbasin transfer applicationscould include compensation and mitigation to thebasin-of-origin. This provision gave transfer appli-cants a means to internalize these project costs.

Whether there exists real economic damage to thebasin of origin in this case is unclear. Certainly, thenotion simply that it is "our water" does not requirecompensation to make the water transfer efficient.However, when the transfer included only the buyerand seller, it is clear that the price of water negotiatedin that process may not have included potential basin-of-origin impacts. More significant than the "ourwater" issue is the uncertain environmental impact ofwhat has been described as a major transfer in theState of Texas. By considering externalities, and theirremediation (for example, the proposed salt waterbarrier), a full cost of the transfer could be estimated.Without consideration of these third party effects, theprice of the transfer could be below its full cost. If so,the transfer would underprice water and lead to aninefficiently large quantity of use in the Houstonarea.

As noted earlier, there are two types of externali-ties for which areas of origin could be compensated —physical and pecuniary. Although it is clear that the



true market value of water must reflect only technicalor physical externalities, policy debates often focus asmuch on pecuniary effects. Indeed, the types of pay-ments being discussed in this case appear to fall intoboth categories. However, since including pecuniaryexternalities in an analysis of compensation wouldrepresent double counting, actual compensationshould be paid only for physical but not pecuniaryexternalities.

In the case of southeast Texas, the considerationsof third party impacts have delayed and perhaps halt-ed the proposed interbasin transfer of water. Theplanning process that was to chose an alternative hasbeen ended without a choice being made. Informationdeveloped thus far has been given to a regional plan-fling system established under the new water legisla-tion. In effect, the consideration of the full cost of thetransfer has made it clear that further information isneeded to make an efficient decision regarding thetransfer.

In standard externality theory, the cost of negativeexternalities can be internalized through a govern-ment tax or regulation. Here the externality is inter-nalized into the water transfer process through therequirement that third party interests and potentialcompensation and mitigation be included in the per-mitting process.

CONCLUSION

The ability to identify and incorporate the full costof transfers is an important consideration whenexploring the use of markets to resolve water con-flicts. In water transfers, the transaction price nor-mally considers only those costs and benefits thataffect the buyer and seller directly. Missing frommany market transactions are the third-party impli-cations of a water transfer. Even the most sophisticat-ed market systems for water rights have yet to offerthe complete resolution of all third-party affects.Pareto-better efficiency requires that only transfersfor which all benefits exceed all costs should occurand that actual compensation be paid for physicalexternalities. If all costs are not accounted for, trans-fers will be implemented for which costs outweighbenefits — producing an inefficient distribution ofresources. Further, if third party interests are notbrought into the transfer process, and thus actualcompensation not considered, water conflicts may con-tinue through court and/or political action. Using afull cost approach to water markets may resolvewater conflicts short of protracted legal action.

Accounting for instream flows, water quality andother economic values that have not normally beenrepresented in water transfers will raise the costsincurred by buyers and sellers above what would havebeen set and may prevent some transfers from occur-ring. Trade-offs exist between the benefits of protect-ing third parties and the public interest, and the costsof doing so. Transfer policies must balance the costs ofprotecting third parties and the benefits foregonewhen these interests are neglected.

ACKNOWLEDGMENTS

Funding for this project came from a grant from the U.S. Geo-logical Survey through the Alabama Water Resources ResearchInstitute. Ann Woods and Jeff Taylor, of Brown and Root (consult-ing engineers for the Trans-Texas Water Program) developed muchof the Texas-related material presented in this paper.

LiTERATURE CITED

Griffin, R. C. and F. 0. Boadu, 1992. Water Marketing in Texas:Opportunities for Reform. Natural Resource Journal 32(2):265-288.

Howe, C. W. and K .W. Easter, 1971. Interbasin Transfers of Water:Economic Issues and Impacts. Resources for the Future, Balti-more, Maryland.

Jordan, J. L., J. B. Blackburn, and G. L. Callaway, 1998. EquityIssues Related to Water Transfers: Southeast Area. A reportprepared for the Trans-Texas Water Program.

Michelsen, A. M., 1994. Administrative, Institutional, andStructural Characteristics of an Active Water Market. WaterResources Bulletin 30(6):971-982.

Moncur, J. E. T. and Y-S Fok, 1993. Water Pricing and Cost Data:Getting the Right Numbers. Water Resources Update 92:35-37.

National Research Council, 1992. Water Transfers in the West: Effi-ciency, Equity, and the Environment. National Academy Press,Washington, D.C.

Raftelis, G. A., 1993. The Role of Pricing in Integrated ResourcePlanning. Proc. 1993 AWWA Annual Conf., San Antonio, Texas.

Randall, A., 1972. Market Solutions for Externality Problems: The-ory and Practice. Am. J. Agric. Economics 54(2): 175-183.

Randall, A., 1983. The Problem of Market Failure. NaturalResources Journal 23(1):131-148.

Randall, A., 1987. Resource Economics: An Economic Approach andNatural Resource and Environmental Policy (Second Edition).John Wiley and Sons, New York, New York.

Sassone, P. G. and W. A. Schaffer, 1978. Cost-Benefit Analysis: AHandbook. Academic Press, New York, New York.

Schmid, A. A., 1989. Benefit-Cost Analysis: A Potential EconomyApproach. Westview Press, Boulder, Colorado.

Tietenberg, T., 1992. Environmental and Natural Resource Eco-nomics (Third Edition). Harper Collins, New York, New York.


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EXTERNALITIES, WATER PRICES, AND WATER TRANSFERS