Water exchanges versus water works: Insights from a computable general equilibrium model for the Balearic Islands

Transcription

1 WATER RESOURCES RESEARCH, VOL. 40,, doi: /2004wr003235, 2004 Water exchange veru water work: Inight from a computable general equilibrium model for the Balearic Iland Carlo M. Gómez Department of Economic, Univerity of Alcalá, Madrid, Spain Dolore Tirado and Javier Rey-Maquieira Department of Applied Economic, Univerity of Balearic Iland, Palma de Mallorca, Spain Received 12 November 2003; revied 1 April 2004; accepted 9 June 2004; publihed 2 October [1] We preent a computable general equilibrium model (CGE) for the Balearic Iland, pecifically performed to analyze the welfare gain aociated with an improvement in the allocation of water right through voluntary water exchange (mainly between the agriculture and urban ector). For the implementation of the empirical model we built the ocial accounting matrix (SAM) from the lat available input-output table of the iland (for the year 1997). Water exchange provide an important alternative to make the allocation of water flexible enough to cope with the cyclical drought that characterize the natural water ime on the iland. The main concluion i that the increaed efficiency provided by water market make thi option more advantageou than the popular alternative of building new dealinization plant. Contrary to common opinion, a water market can alo have poitive and ignificant impact on the agricultural income. INDEX TERMS: 6304 Policy Science: Benefit-cot analyi; 6334 Policy Science: Regional planning; 6339 Policy Science: Sytem deign; 6344 Policy Science: Sytem operation and management; KEYWORDS: efficiency, general equilibrium analyi, water economic Citation: Gómez, C. M., D. Tirado, and J. Rey-Maquieira (2004), Water exchange veru water work: Inight from a computable general equilibrium model for the Balearic Iland, Water Reour. Re., 40,, doi: /2004wr Introduction [2] The Balearic Iland, located eat of the Iberian Peninula in the Mediterranean Sea, preent ome critical environmental problem due to periodical drought (when water reerve fall to 30% or 50% with repect to average year) and to the annual ime of water between winter (65% of rainfall) and ummer when the demand for water i at it peak. (In the year 2000, a evere dry year, reerve fell to 30.7% in Mallorca, to 5.51% in Minorca and below 20% in Ibiza. Becaue of the lack of permanent river and dam 90% of the water upply i obtained from underground pring.) During the lat few year there ha been an increaing concern for the conflict of water ue coming from the rapid development of tourim and the traditional ue of water in the agricultural ector. Tourim ha increaed the tationary population of the iland to 34% of the total population, and the rural ector ue till repreent 60% of water demand, a can be een in Table 1. Furthermore, according to the Hydrological Plan of the Balearic Iland, the urban demand will keep growing. [3] To cope with increaing demand, phyical carcity and conflict of water ue the local water authoritie have reponded with ome policy meaure including: firt, retriction of water upply in drought period, with water Copyright 2004 by the American Geophyical Union /04/2004WR hortage in many town. Second, overexploitation of underground reerve with evere conequence in irreverible alinization of ome important water mill. Third, water import from the Ebro River Bain on the continent. (Thi Ship Operation, which tarted in 1994 and lated for 30 month, allowed the tranfer of 17 cubic hectometer, a mall quantity in relation to the local water demand at a cot of over C¼ 2 per cubic meter, not including the 9 million inveted in the infratructure built to make the tranfer poible.) Finally, ince 1994, the main trategy ha conited in the building up of new dealinization facilitie. [4] All thee trategie reflect the common and traditional view that water management mut rely on meaure toward an increaed upply with little concern for reduced demand option and increaed efficiency in water allocation. The prevalent opinion of the expert i that thi traditional view ha had a high economic cot in the hort term, and ha increaed water carcity in the long term. Mot of the economic cot and environmental damage could have been avoided if alternative policie of demand management, uch a water recycling and aving, and increaed efficiency mainly through voluntary water exchange, had been applied. [5] In thi paper we analyze the potential welfare gain aociated with the development of a water market in the Balearic Iland. For thi purpoe we provide a computable general equilibrium model, pecifically deigned for the ional economy of the iland, and extended to include 1of11

2 GÓMEZ ET AL.: WATER MARKETS VERSUS WATER WORKS Table 1. Water Demand and Water Source Per Sector a Underground Dealinization Water Reervoir Watewater Treated Total Conumption Share, % Public Conumption b Irrigation Indutry c Golf field irrigation Total Supply hare, % a Elaborated from data of the PHIB, Govern de le Ille Balear [1999]. Value are in hm 3 /year. b Ued to irrigate public garden and park. c Private ue not connected to the public water network. water demand and upply. The model i ued to ak whether there are poitive gain in reallocating water right from the rural to the urban ector in a drought period. We alo anwer ome quetion about the way uch a market will work, and provide ome robut anwer that how the advantage of market over increaed upply meaure. The fully pecified CGE model of the Balearic Iland i given by Tirado [2003]. 2of11 2. General Equilibrium Model and Water Policy Analyi [6] Although we can obtain ome important inight from partial equilibrium analyi, thi framework, when put into practice, i of a limited ue for the analyi of the efficiency of water right allocation. The main criticim come from the fact that water i ued in almot all production activitie, being an eential input in many of them, and alo from the fact that water value i highly dependent on time and location. Any change in the ditribution of property right over water will probably have conequence on the ectoral compoition of the economic product, on employment, on cot and price, and on the income ditribution between the rural and urban ector. A market of property right will undoubtedly increae efficiency but, a partial analyi alo lead to partial anwer, in the cae of water policy, when many effect are a matter of political concern, it i alo neceary to provide a framework able to capture all the relevant economic effect of a changed tructure of water property right. [7] Applied general equilibrium model for water management are well uited to compare alternative policy cenario, uch a that of Berck et al. [1991], who ue a CGE which tudie the reduction of water ue in San Joaquim Valley a an efficient alternative to olve drainage problem, or the work of Dixon [1990], Horridge et al. [1993], Decaluwé et al.[1999], and Thabet et al. [1999] to analyze the impact and efficiency of water price. Neverthele, the ue of CGE to analyze the reallocation of water right between uer i le common. Seung et al. [1998] tudied the welfare gain of tranferring water from agricultural to recreational ue in the Walker River Bain (located in northwetern Nevada and in California). Seung et al. [2000] combined a dynamic CGE model with a recreation demand model to analyze the temporal effect of water reallocation in Churchill County (Nevada). Diao and Roe [2000] provide a CGE model to analyze the conequence of a protectionit agricultural policy in Morocco and how how the liberalization of agricultural market create the neceary condition for the implementation of efficient water pricing (particularly through the poibility of a market for water in the rural ector). By uing an applied CGE, Goodman [2000] how how temporary water exchange provide a lower cot option than the building up of new dam or the enlargement of the exiting water torage facilitie. [8] To um up, the analyi of water allocation then require a comprehenive view of the economy, and applied CGE methodology give a potential framework to ae and compare policy option. For thi purpoe we ue a CGE to analyze the implementation of a water market in the Balearic Iland. Thi CGE will alo allow u to quantitatively and qualitatively compare the advantage of market over other alternative uch a dealinization plant. 3. Baic Model Structure [9] We have performed a tatic theoretical model that trie to capture both the economic tructure and the hydrological problem of the Balearic Iland. For thi purpoe, we ditinguih ten economic ector: two of them producing agricultural good (with and without irrigation), a third ector with livetock, mining, fihing and the ret of primary activitie, two ector involved in the production of drinking water (the traditional one and the one baed on dealinization of eawater), and the ector of energy, manufacture, contruction, tourim and ervice. [10] Any ector produce a particular good or ervice except the two water ector. The dealinization ector produce and ditribute the ame product a the traditional drinking water facilitie, but with a different cot tructure. Although irrigated and nonirrigated agriculture are different production technique that can potentially be ued to produce the ame crop, given the condition of the iland we aume that good produced by the two agricultural ector in our model are imperfect ubtitute. In thi cae the overall product of the agricultural ector will be an Armington aggate of both. When working with aggate data, countrie normally appear to import, produce and export the ame kind of good. The Armington olution conit in auming that both export and dometic production on the one hand and import and dometic production on the other, are imperfect ubtitute. [11] The economy ue five production factor: land, capital, labor, water and eawater. Land i only ued in agriculture and i mobile among both the irrigated and nonirrigated ector. Capital i pecific of any ector except in agriculture where it i mobile between irrigated and nonirrigated. Labor i mobile. Furthermore, at a firt ap-

3 GÓMEZ ET AL.: WATER MARKETS VERSUS WATER WORKS Figure 1. Production technology of the irrigated crop ector. proximation, water upply i aumed to be fixed and water right, actually ditributed among agriculture and water upply firm, are not tradable. [12] Farmer and water upply firm own ome conceional water right over ome quantitie of underground water that mut be ued for a pre-pecified purpoe and they are not initially allowed to buy or ell thee water right. Water i a primary nontranferable production factor; moreover, a it may be extracted there water i produced with a certain cot. Drinking water i produced and ditributed by uing other production factor and i ued a a final good by conumer or a an intermediate good by the other ector of the economy. The aumption of nontranferability of water property right i removed to tudy the potential welfare gain of water trade between agriculture and water upply depending of the level of raw water upply that i aumed to be exogenouly determined by the degree of drought. Seawater upply i aumed fixed and determined by the available dealinization capacity. [13] There are four agent in the economy: conumer, firm, government and the ret of the world. Conumer are identical and they own the initial endowment of land, labor, capital, water and eawater. There i alo a repreentative firm in any economic ector and the only activity of the public ector conit in collecting the tax revenue and ditributing them to conumer a lump-um income tranfer. [14] The Balearic Iland are aumed to be a mall open economy and, conequently, import demand and export upply of any good or ervice but tourim are determined by world price. The relative importance of tourim for the Balearic economy lead u to aume a demand for tourim with a negative lope. We ue an Armington aumption to cope with imperfect ubtitutability between dometic and foreign produced good. Finally, contruction and drinking water are aumed to produce nontradable good Agricultural Technology [15] A agriculture i the main uer of raw water, the potential advantage of water exchange are heavily dependent on the available poibilitie of ubtitution between primary production factor in thi ector. Additionally the agricultural ector may adjut itelf to a hortage or a price increae in water reource by changing it compoition between irrigated and nonirrigated crop. To include all thee adjutment alternative, we model both irrigated and nonirrigated crop production technologie a neted multilevel CES, a hown in Figure 1. The only difference between the two technologie i that the nonirrigated ector doe not ue raw water. CES (contant elaticity of ubtitution) function are widely ued in CGE modeling to repreent both production and utility. They have the advantage of being well behaved, with a decent degree of flexibility and conitent with aumption ued in CGE model (linear homogeneity/homothecity). The tandard two-variable CES production function may be written a Y ¼ A½bK r þ ð1 bþl r where Y i the output, K and L the two production factor, A i a cale parameter, b and (1 b), repectively, repreent the hare of factor K and factor L in total factor payment and r i related to the elaticity of ubtitution = 1/(1 r). [16] One drawback of the CES function i that the elaticity of ubtitution between any pair of good or factor i contant. To pecify that thi elaticity between member of one ubet of good or factor i different from Š 1 r 3of11

4 GÓMEZ ET AL.: WATER MARKETS VERSUS WATER WORKS Figure 2. Production technology of other ector. the one between member of one ubet and member of another, it i neceary to combine the CES with another kind of function. [17] The bottom right ide of Figure 1 how the Leontief raw water extraction technology (RW) meaning that producing water for crop require underground water and energy. The Leontief (fixed coefficient) function i a pecial cae of the CES function when! 0. Thi function i commonly ued to model the ue of intermediate (manufactured) input which are combined with the other factor of production to produce the final good. The CGE model available in the literature do not explicitly conider that water for agriculture i a produced input. Following Boyd and Newman [1991] and Decaluwé etal.[1999] we aume that capital and land are alo CES aggate (KT). Firt level aggate input, raw water and the compoite capital land are pecific production factor of the agricultural ector. Similar to that of Goodman [2000], our model i more flexible than the alternative provided by, i.e., Berck et al. [1991] and Seung et al. [1998], where land and water enter in the production function with fixed Leontief coefficient. [18] In a econd level the compoite land-capital and raw water are combined in the CES compoite KTW, which in a third aggation level i combined with labor (L) to obtain a CES compoite (KLTW) of all capital, labor and nature production factor. Finally, the combination of all thee factor with an aggate of intermediate input i combined with a Leontief technology to obtain the final output of the crop-irrigated ector. The nonirrigated ector i imilar except that the RW net doe not apply. [19] The overall crop production i an aggate of irrigated and nonirrigated output with a contant elaticity function. Thi way, the overall agricultural output Y agr,a hown in the equation below, mut be in equilibrium with the internal and external demand, D agr and X agr, and 4of11 following the Armington methodology we aume a contant tranformation elaticity of thi tradable good: Y agr ¼ f Y ; Y ec ¼ gdagr ; X agr 3.2. Noncrop Production Technology [20] The water production and ditribution ector Wp, extract water available underground and tranform it into drinking water by uing capital, labor and intermediate input in fixed proportion. The alternative in cae of underground water hortage conit in the dealinization of eawater and in thi cae we aume a Leontief production function that ue capital, labor and intermediate input. The overall drinking water production i then the um of traditional drinking water production Wp and dealinated water Wd. Given the relatively high cot of dealinization, thi ector will only be active when the quantity of underground water available i below a certain threhold and we aume that in the baeline cenario (when there i no drought problem) thi ector i not active. [21] Apart from crop and drinkable water production function, all other production technologie are pecified by a three level neted production function a repreented in Figure 2. Thi production tructure i more flexible than the model preented in the literature and i jutified by the empirical demontration that water demand i rather flexible and can be ubtantially reduced during drought period (i.e., by water aving campaign or the intallation of water aving device in-houehold and firm). [22] At the firt level, capital and drinkable water are combined with a CES technology to obtain the KDW compoite. At the econd level, thi KDW compoite i combined with labor uing Cobb-Dougla technology (the Cobb-Dougla function i a pecial cae of the CES function when! 1) to obtain the VAP aggate, which,

5 GÓMEZ ET AL.: WATER MARKETS VERSUS WATER WORKS Table 2. Input-Output Table of the Balearic Iland 1997, Aggated in 10 Sector a Agriculture Nonirrigated Irrigated Livetock and Fihing Energy Water Production Manufacture Contruction Tourim Service Intermediate Export Invetment Final Conumption Final Demand Total Ue Agriculture Nonirrigated Irrigated Livetock and fihing Energy , Water production Manufacture , , , , Contruction , , , Tourim , , , Service , , , , , Intermediate , , , , , , , , , , Labor , , , Land Capital , , , Gro Value , , , , Indirect Taxe Subidie Gro Value Added mp c , , , , Total output , , , , , Import , , Vat , Total upply , , , , , , a Elaborated from 1997 input output table of the Balearic Iland [Govern de Ille Balear, 2004]. Value are in million of euro. b At factor price. c At market price. 5of11

6 GÓMEZ ET AL.: WATER MARKETS VERSUS WATER WORKS Table 3. Parameter of the Balearic CGE Model Elaticitie Value Subtitution elaticity in the irrigated agricultural ector Capital and land a =0.3 Aggate capital-land and aggate water for crop =0.2 Land and aggate capital-land-water for crop a =0.7 Subtitution elaticity in the nonirrigated agricultural ector Capital and land ec =0.3 Labor and aggate capital-land ec =0.7 Subtitution elaticity in other ector Capital and water kap =0.3 Subtitution elaticity between imported and dometically produced good b ar g =4 Subtitution elaticity between irrigated and nonirrigated agricultural product agr =1 Price elaticity of export demand for tourim c e= 2 Tranformation elaticity of production d W agr = W =2 a Boyd and Newman [1991] and Seung et al. [1998]. b Goodman [2000]. c Blake [2000]. d Equal to all ector and obtained a the average of the tranformation elaticitie conidered by Seung et al. [1998]. mixed in fixed proportion with intermediate input, lead to the production of the final good Y. [23] Each ector produce two kind of good, thoe for the dometic market D and thoe for the foreign market X, which are aggated by the CET function g(d, X). A far a algebra i concerned, contant elaticity of tranformation function (CET) are imilar to CES function, but wherea CES function pecify an output a a function of a number of input, CET function pecify an input a a function of a number of output (ee ection A8) Final Demand and Macroeconomic Equilibrium [24] There are two kind of taxe collected by the public ector and returned to conumer a lump um tranfer. Indirect taxe over the production (independently if they are conumed dometically or exported) and a value added tax over the Armington aggate. [25] In thi context the final demand i compoed by invetment (INV), conumption and import. In the hort term invetment i exogenou and i defined by a Leontief aggate of traded and nontraded good. Import demand and export upply are determined by external price and are both defined by uing the normal Armington aumption. The foreign demand for tourim ervice preent a contant ubtitution elaticity. [26] In the baeline cenario there i an external trade urplu that, ince our economy doe not conider external capital flow, we will ard a contant. For thi purpoe an artificial good i introduced [ee Löfgren et al., 2001; Blake, 2000; Boyd and Newman, 1991]. The price of thi good (pfx), equivalent to the real exchange rate, will balance the external ector. The abence of capital flow i equivalent to a certain internal aving which allow the external balance. [27] Conumer maximize a Stone-Geary utility function. The Stone-Geary function can modify either the Cobb- Dougla (our cae) or CES utility function to pecify a minimum level of demand of each good (in our cae only water) (ee ection A9). Conumer income i obtained by the um of primary factor revenue and lump um tranfer. Conumption expenditure i obtained after deducing invetment and net aving from conumer income. Drinking water i an eential conumer good and we aume that there i a minimum ubitence quantity of drinkable water that mut be upplied in any cae. Given the lack of data we aume that thi ubitence level i equivalent to the 70 L per day recommended by the United Nation. 4. Implementation of the Empirical Model [28] The baic data come from the 1997 input output table of the Balearic Iland [Govern de Ille Balear, 2004] from which we built the ocial accounting matrix (SAM) preented in Table 2 (the 55 ector were grouped into the eight mentioned above). [29] Agricultural production ha been diaggated into different crop following the claification and data provided by the National Agrarian Accounting Network (Red Contable Agraria Nacional [Miniterio de Agricultura, Peca y Alimentación. Secretaría General Técnica (MAPA), 1999]) and the Balearic Government. Finally, all crop output were rouped to obtain the irrigated and nonirrigated production value that were incorporated in the I-O matrix. Labor income wa obtained by adding wage and ocial ecurity payment. Land rent were obtained from data provided by the land price urvey of Capital gain in the agricultural ector were obtained by ubtracting labor income and land rent from agricultural gro value added to factor price. [30] Nonreident conumption repreent an important hare of total conumption expenditure in the Balearic economy reflecting the relative economic importance of tourim. For implicity, we treat tourit conumption a export. Collective or public conumption wa alo aumed a part of the conumption expenditure of the repreentative agent. [31] Water endowment were obtained from the hydrological plan of the Balearic Iland a the effective water applied to any crop in 1997 and the effective water conumption were obtained after conidering a return flow of 22%. [32] For the water dealinization ector we ue the etimated cot of 0.58 euro in 1997 per cubic meter of drinking water (provided by the water upply authority of Palma de Mallorca (EMAYA)) with an intalled capacity of producing 30 cubic hectometer (we aume thi to be the endowment of eawater in the baeline cenario). The cot 6of11

7 GÓMEZ ET AL.: WATER MARKETS VERSUS WATER WORKS Figure 3. Shadow and market price of raw water. Figure 5. Production of drinking water. ditribution between the different factor intervening in the dealinization proce ha been obtained by uing the information about engineering cot for thi kind of plant [ee Centro de Etudio y Experimentación de Obra Pública (CEDEX), 1995]. [33] In ome cae ubtitution and tranformation elaticitie have been obtained from previou tudie and in other they have been aumed. In any cae, we preent ome element further on to etimate the robutne of our etimate. All the remaining parameter have been obtained by calibration of the theoretical model with the ocial accounting matrix (ee Table 3). 5. Model Calibration [34] The model ha been calibrated by uing the MPSGE (mathematical program ytem for general equilibrium) module of the GAMS (general algebraic modeling ytem) programming platform [GAMS Development Corp., 2001]. [35] Except for water, we followed the uual Harberger convention of etting initial price to the unity (with the obviou exception caued by the exitence of indirect taxe). In the cae of drinking water, a the quantity produced mut be equal to the raw water ued a input, the price will be higher than the unity and i calibrated by uing the fact that the Leontief coefficient (relating raw and drinking water) i equal to one. [36] The abence of a market for water in the agricultural ector implie a reference price of zero in the benchmark cenario. In thi cae, the only way to calibrate a CES production function i to aume that the input (underground water) i combined with another marketed input in fixed proportion (in our cae: energy). Finally, labor price i taken a numerary (the model and data are available from author upon requet). 6. Main Reult [37] The benchmark, or the calibrated baeline cenario, in which no water exchange are allowed, i baic to obtain the no water market ituation (NM). The counterfactual ituation where water right are poible (WM) i obtained by auming that raw water i not a ector pecific input anymore and that water endowment can be freely old until their marginal productivity i equated among the agricultural and the drinkable water production ector. [38] To how the difference between both ituation (with and without water exchange), we run eleven imulation of drought cenario by conidering equential reduction of 5% of the initial water endowment. The bae year of 1997, according to Tirado [2003], wa conidered an almot normal rainfall year. [39] Firt, water market will reult in a better allocation of water among crop and drinking water production. Figure 3 how the relevant water price for different drought level. In the nonmarket ituation, repreented by the bold line traced for the price of urban raw water Figure 4. Total water tranferred. Figure 6. Drinking water price. 7of11

8 GÓMEZ ET AL.: WATER MARKETS VERSUS WATER WORKS Table 4. Drought Effect on Sectoral Output Under Different Intitutional Framework (Percent of Variation Over Baeline Scenario) Drought Severity a a Percent Reduction in Water Availability Over Baeline Scenario (SB) 5% 15% 25% 35% 45% 55% Nonmarket Scenario Irrigated agriculture Nonirrigated agriculture Livetock and fihing Energy Water production and ditribution Manufacture Contruction Service Tourim Water Market Scenario Irrigated agriculture Nonirrigated agriculture Livetock and fihing Energy Water production and ditribution Manufacture Contruction Service Tourim endowment (Puw) and the price of raw water endowment for agriculture (Paw), the diverging pattern of both hadow water price how the reduced ability of urban water demand to adapt to water hortage. A the agricultural hadow price increae moothly with drought, the price curve of raw water for the urban ector i teeper and the price grow until the alternative of dealinization eawater become profitable. A further increae in the hadow price of urban water will take place only when the capacity of the dealinization plant if fully ued in a evere drought which reduce the water upply in more than 55%. [40] The diverging repone of hadow water price in a period of drought allow mutually benefiting interchange of water endowment between the agriculture and the urban ector. Thi i hown in Figure 3 by the intermediate price line that i obtained in the counterfactual market ituation when the price of water i equalized for any economic ue (Pm). Figure 4 how the water quantity that may be effectively old by the rural ector. [41] Second, hypothetical water market would reduce the negative impact of drought over drinking water conumption. A hown in Figure 5, in a nonmarket ituation (the lower curve) the production of drinking water need to be everely reduced to increae water price until the current market price of drinking water i high enough for it production from eawater to be worth it. On the contrary, with voluntary water exchange, the baeline upply of drinking water can be maintained even with an intermediate drought that reduce the initial raw water endowment by 30%. A can be expected the final price of drinking water paid by conumer can alo be maintained if voluntary water exchange are allowed, and no price increae would be neceary before a drought index of 30% i reached (a hown in Figure 6). In hort, in a market ituation, drinking water cutomer benefit both from higher upply and lower price with repect to a ituation when water i not voluntarily traded. [42] Third, the effect of drought on the irrigated crop production i necearily negative in both intitutional framework. In the market ituation, a hown in Table 4, the output reduction in thi ector i higher than when the ale of water right i not allowed. Moreover, contrary to the nonmarket ituation, the income obtained by water right ale will guarantee that the overall factor payment in thi ector would alway be higher if water exchange are allowed. Table 5 how that in the nonmarket ituation the rural income diminihe with drought contrary to the market ituation when it alway increae. The reduction of agricultural production reulting from the lower irrigated activity i partially compenated by the increaed production Table 5. Drought Effect on Agricultural Income (Percent Over Baeline Scenario) and the Hick Equivalent Variation (Percent of Income From Baeline) Drought Severity a a Percent Reduction in Water Availability Over Baeline Scenario (SB) 5% 15% 25% 35% 45% 55% Nonmarket Scenario Rural income Regional welfare Water Market Scenario Rural income Regional welfare of11

9 GÓMEZ ET AL.: WATER MARKETS VERSUS WATER WORKS of the nonirrigated crop, thi increae being alo higher in the market ituation due to the reallocation of production factor from the irrigated ector. [43] Fourth, higher drinking upply and lower price aociated with the water market ituation can alo explain a relatively higher activity level in other ector of the economy. A hown in Table 4, thee effect are lower than the one on drinking water production and crop mentioned above. In ome cae the effect i eay to undertand, a it happen in the energy ector the demand of which increae with the entry of the dealinization plant. It i alo worth mentioning that the effect of drought over tourim, the main economic activity of the iland, i clearly negative in the nonmarket intitutional framework and, contrary to that, i ytematically poitive if voluntary water exchange are allowed. Neverthele, thee general equilibrium ectoral effect mut be the ubject of further reearch. [44] Finally, it i very important to how that the preence or abence of a water market play a crucial role in the aement of the convenience of maintaining the exiting facilitie to increae the upply of raw water (or of building new facilitie for the ame purpoe). In the cae of our model, the exiting water dealinization plant repreent thi kind of facilitie. A can be een in Figure 3 6 and in the reult preented in Appendix A, the dealinization plant i only active now when voluntary water exchange are not allowed. In other word, water market could be an important mean to obtain ubtantial aving of reource actually ued to maintain and increae the infratructure for water ulation. Additionally, if water market make ome of thee facilitie redundant, other ditortion effect produced by the operation of thi infratructure can alo be avoided: in our model of the Balearic Iland the price and production of energy are both higher when the dealinization plant i operative implying higher production cot for the entire economy. [45] In Table 5 we alo how an etimate of the Hickian equivalent variation of the repreentative agent a a meaure to capture all the welfare effect mentioned above. In both intitutional framework welfare i a decreaing function of drought. Neverthele the welfare lo i higher in the nonmarket ituation. The atifactory reult obtained when uing the Gauian quadrature methodology have hown the robutne of the model. 7. Concluion [46] We have preented a CGE of the Balearic economy that ha been ued to tet the uperiority of voluntary Water exchange over the common ituation of fixed water endowment. We argue that the potential efficiency gain are important in term of reduced water price, increaed upply and the increaed ability of ociety to adapt to recurrent drought ituation. [47] We howed that although agricultural production i lower when there i a market for water right than when there i not uch a market, thi doe not mean a lower rural or agricultural income but, on the contrary, if rural income need to be maintained, the ownerhip of tradable water right could lead to an efficient intitutional etting for increaing efficiency in the overall economy. [48] Water market will alo be the way to obtain ubtantial aving by avoiding the building up of ome water ulation infratructure (dam, dealinization plant, water tranfer facilitie) and alo to eliminate the economic ditortion that may be produced by the operation of thi redundant infratructure, a i the cae of increaed energy price produced by the dealinization activity in the Balearic CGE Model. Before generalizing thee concluion it mut be conidered that the model preented i a firt approximation and it reult mut be undertood a the potential welfare benefit of water market in a particular economy. On the other hand, the welfare benefit of water market may be lower than expected if tranaction cot are, a preumed by the author, other than zero (which i actually one of the hidden aumption of our model). Although we do not offer an explicit treatment of tranaction cot, at leat our model give a preliminary anwer to the quetion of how high the tranaction cot of water exchange hould be for water remaining a nonmarketable input to be the bet option. Appendix A: General Equilibrium Model Decription A1. Production Technology of the Irrigated Agricultural Sector [49] RW ¼ min AS ; A en; ; ða1þ aa ee where RW i the compoite input water for crop, AS i the volume of underground water ued, A en, i the e of the Armington aggate of the energy ector, and aa and ee are Leontief coefficient. h i 1 KT ¼ A b Kr þ 1 b T r r ; ða2þ where KT i compoite land capital, K i capital, T i land, A i the efficiency parameter, b i the capital hare parameter, r i the ubtitution parameter, and i the ubtitution elaticity. h i 1 KTW ¼ A ka bka rka KT þ 1 b ka RW rka r ka ; ða3þ ka where KTW i compoite KT y RW, A i the efficiency parameter, b ka i the hare parameter, r ka i the ubtitution parameter, and ka i ubtitution elaticity. h i 1 KLTW ¼ A la bla Lrla þ 1 b la KTW rla r la ða4þ where KLTW i compoite KTW and labor, L i labor, A la i the efficiency parameter, b la i the hare parameter, and r la i the ubtitution parameter, and la i ubtitution elaticity. KLTW Y ¼ min ; A 1; ; A 2; vaa iia 1; iia 2; ;...; A g; iia g; ; II 1; iia 1; ; II 2; iia 2; ;...; II i; iia i; ; ða5þ where g 2 BM i a et of traded production ector, i 2 BNM i a et of nontraded production ector, Y i output of 9of11

10 GÓMEZ ET AL.: WATER MARKETS VERSUS WATER WORKS irrigated agriculture, II i, i ue of the intermediate input of the ector i, A g, i ue of the Armington aggate of the ector g, and vaa, iia g,, and iia i, are technical fixed coefficient. A2. Production Function of the Nonirrigated Agricultural Sector [50] h KT ec ¼ A i ec b ec Kr ec ec þ 1 b ec T r 1 ec r ec ec ; ða6þ where KT ec i compoite land capital, K ec i capital, T ec i land, A ec i the efficiency parameter, b ec i the hare parameter, r ec i the ubtitution parameter, and ec i ubtitution elaticity. h LKT ec ¼ A lk i ec blk ec Lrlk ec ec þ 1 blk ec KT r lk 1 ec r lk ec ec ; ða7þ where LKT ec i compoite land capital labor, L ec i labor, lk lk A ec i the efficiency parameter, b ec i the hare parameter, lk lk r ec i the ubtitution parameter, and ec i ubtitution elaticity. LKTec Y ec ¼ min ; A 1;ec ; A 2;ec ;...; vaa ec iia 1;ec iia 2;ec A g;ec ; II 1;ec ; II 2;ec ;...; II i;ec ; ða8þ iia g;ec iia 1;ec iia 2;ec iia i;ec where Y ec i output of nonirrigated crop, II i,ec i ue of the intermediate input of the ector i, A g,ec i ue of the Armington aggate of the ector g, vaa ec, iia g,ec, and iia i,ec are technical fixed coefficient. A3. Overall Agricultural Output [51] Y agr ¼ f Y ; Y ec ¼ Aagr b agr Y r agr þ 1 b agr r Y agr 1 r agr ec ; ða9þ where Y agr i agricultural output, A agr i the cale parameter, b agr i the hare parameter, r agr i the ubtitution parameter, and agr i ubtitution elaticity. A4. Water Production and Ditribution [52] Y wp ¼ min Kwp ka wp ; L wp la wp ; AS wp au wp ; A 1;wp iia 1;wp ; A 2;wp A g;wp iia g;wp ; II 1;wp iia 1;wp ; II 2;wp iia 2;wp ;...; II i;wp iia i;wp ;...; iia 2;wp ; ða10þ where Y wp i water produced, K wp i capital, L wp i labor, AS wp i raw water, ka wp, la wp, au wp, iia g,wp, and iia i,wp are technical fixed coefficient, II i,wp i ue of the intermediate input of the ector i, and A g,wp i ue of the Armington aggate of the ector g. A5. Water Production From Dealinization [53] Y d ¼ min K d ; L d ; AM d ; A 1;d ; A 2;d ;...; A g;d ; ða11þ ka d la d ma d iia 1;d iia 2;d iia g;d where Y d i output, K d i capital, L d i labor, AM d i quantity of eawater, ka d, la d, ma d, and iia g,d are technical fixed coefficient, and A g,d i ue of the Armington aggate of the ector g. A6. Other Product [54] KDW ¼ A kap h b kap K rkap þ 1 b kap i D r kap 1 w; r kap ; ða12þ where KDW i compoite capital-water, K i capital ued by ector, D w, i water ued by ector, A kap i the efficiency parameter, b kap i the hare parameter, r kap i the ubtitution parameter, and kap i ubtitution elaticity. VAP ¼ B vap L avap ð KDW 1 avap Þ ; ða13þ where VAP S i compoite KDW and labor, L i labor, B vap i the efficiency parameter, and a vap i the hare parameter. Y ¼ min VAP ; A 1; ; A 2; ;...; A g; ; II co; ; ða14þ vva iia 1; iia 2; iia g; iia co; where Y i production of ector, II co, i ue of the intermediate input of the ector I, A g, i ue of the Armington aggate of the ector g, vva, iia g,, and iia co, are technical fixed coefficient. A7. Invetment [55] INV ¼ min A 1;inv ; A 2;inv ;...; A g;inv D 1;inv ; ; D 2;inv ;...; D i;inv in 1;inv in 2;inv in g;inv in 1;inv in 2;inv in i;inv ða15þ where INV i production of capital good, D i,inv i ue of the dometic production of the ector I, A g,inv i ue of the Armington aggate of the ector g, and in g,inv and in i,inv are technical fixed coefficient. A8. External Trade A8.1. Tranformation Function [56] gd ð ; X Þ ¼ A t q D h þ ð1 q ÞX h 1 hr; ða16þ where D i dometic demand for product of ector, X t i export demand for good of ector, A i the cale parameter of the ector, q i the hare parameter, h i the tranformation parameter, and W i tranformation elaticity. A8.2. [57] Armington Aggate A g ¼ A ar g h i a g D rar g r g þ 1 a g M ar 1 g r ar g g 8g; ða17þ where D g i dometic output of the ector g, M g i import demand of ector g, A ar g i the cale parameter of the ector ar g, a g i the hare parameter g, r g i the ubtitution parameter, and a ar g i the ubtitution elaticity. A8.3. [58] Tourim PEX e tu X tu ¼ X tu ; ða18þ pfx 10 of 11

11 GÓMEZ ET AL.: WATER MARKETS VERSUS WATER WORKS where X tu i export demand, X tu i the initial export demand of tourim, PEX tu i the price of tourim, pfx i the real exchange rate, and e i the demand price elaticity. A9. Conumption [59] C ¼ ðc w g w Þ ac w C ac co co Y 6 g¼1 C ac g g ; ða19þ where g 2 BM i the et of traded good, C w i drinking water conumption, C co i contruction good, C g i ector g produced good conumption, g w i minimum ubitence conumption of drinking water, and a c g, a c co, and a c w are hare parameter. Reference Berck, P., S. Robinon, and G. Goldman (1991), The ue of computable general equilibrium model to ae water policie, in The Economic Management of Water and Drainage in Agriculture, edited by A. Dinar and D. Zilberman, pp , Kluwer Acad., Norwell, Ma. Blake, A. (2000), The economic effect of tourim in Spain, TTRI Dic. Pap. 2000/2, Tourim and Travel Re. Int., Univ. of Nottingham, Nottingham, U. K. Boyd, R., and D. H. Newman (1991), Tax reform and land-uing ector in the U.S. economy: A general equilibrium analyi, Am. J. Agric. Econ., 73, Centro de Etudio y Experimentación de Obra Pública (CEDEX) (1995), Lo proceo de dealación y lo cote del agua dealada, report, D.G. Obra Pública, Minit. de Obra Pública, Tranporte y M.A., Madrid, Feb. Decaluwé, B., A. Patry, and L. Savard (1999), When water i no longer heaven ent: Comparative pricing analyi in an AGE model, Working Pap. 9908, CRÉFA 99-05, Dép. d Econ., Univ. Laval, Quebec, Canada. Diao, X., and T. Roe (2000), The win-win effect of joint and trade reform on interet group in irrigated agriculture in Morocco, in The Political Economy of Water Pricing Reform, edited by A. Dinar, pp , Oxford Univ. Pre, New York. Dixon, P. B. (1990), A general equilibrium approach to public utility pricing: Determining price for a water authority, J. Policy Model., 12(4), GAMS Development Corp. (2001), GAMS verion 2.5, olver PATH, oftware, Wahington, D. C. Goodman, D. J. (2000), More reervoir or tranfer? A computable general equilibrium analyi of projected water hortage in the Arkana River Bain, J. Agric. Reour. Econ., 25(2), Govern de le Ille Balear (1999), Propueta del Plan Hidrológico de la Ila Baleare, memoria, Bol. Oficial Ille Balear 77, pp , Palma, Spain, June. Govern de Ille Balear (2004), La Tabla Input-Output y el Sitema de Cuenta Regionale para la Comunidad Autónoma de la Ila Baleare, technical report, Palma, Spain. Horridge, J. M., P. B. Dixon, M. T. Rimmern (1993), Water pricing and invetment in Melborne: General equilibrium analyi with uncertain treamflow, Working Pap. IP-63, Cent. of Policy Stud. and the Impact Proj., Monah Univ., Melbourne, Victoria, Autralia. Löfgren, H., R. L. Harri, and S. Robinon (2001), An Etandar computable general equilibrium (CGE) model in GAMS, TMD Dic. Pap. 75, Trade and Macroecon. Div., Int. Food Policy Re. Int., Wahington, D. C., May. Miniterio de Agricultura, Peca y Alimentación. Secretaría General Técnica (MAPA) (1999), Red Contable Agraria Nacional. Metodología y reultado empreariale 1997, report, Madrid. Seung, C. K., T. R. Harri, T. R. MacDiarmid, and W. D. Shaw (1998), Economic impact of water reallocation: A CGE analyi for the Walker River Bain of Nevada and California, J. Reg. Anal. Policy, 28(2), Seung, C. K., T. R. Harri, J. E. Y. Englin, and R. N. Noelwah (2000), Impact of water reallocation: A combined computable general equilibrium and recreation demand model approach, Ann. Reg. Sci., 34, Thabet, C., B. MacGor, and Y. Surry (1999), Effect macro-économique de la politique du prix de l eau d irrigation en Tuniie, Econ. Rurale, 254, Tirado, D. (2003), Análii Económico de la reaignación del agua a travé del mercado: Un modelo de equilibrio general computable para Baleare, doctoral thei, Dep. d Econ. Apl., Univ. de le Ille Balear. C. M. Gómez, Departament of Economic, Univeridad de Alcalá, Plaza de la Victoria /n, Alcalá de Henare, Madrid, Spain. (mario. gomez@uah.e) J. Rey-Maquieira and D. Tirado, Departamento de Economía Aplicada, Univeridad de Ila Baleare, Campu Univeritario, Ctra de Valldemoa, Km. 7,5, E Palma de Mallorca, Spain. (javier.rey@uib.e; dolore. tirado@uib.e) 11 of 11