can be adequately treated widin the existing benefit-cost Economic theory provides "second best" pricing methodology. These methods have only received sporadic algorithms for such circumitaces. However, according to applicationinactualprojectevaluation. FisherandRaucher Hanke and Davis (1973) even these lead to problems for (1984)reportonseveral suchstudiesbut additionalworkis utility managers. Tha:efore they suggested the need to needed to develop this methodology for the types of develop "third best" pricing methods, which would be projects supported by the Bank. more responsive to the political dh'.ensions of water resource pricing. In a study of water conservation in Perth, _C. The political economy of tariffse mng in the water_ Australia,HLanke (1982) outlineshowtoesti;nat **e** conond- _sector._ The political economy oftariffsetting is extremely cally efficient choices considering the resource coa to the important andhas to alarge extentbeen neglectedby water utility, the resource cost to the consumers, and the useful experts. This is particularly true in the cases often encoun- consumption foregone as a result of a particular .onservatered when there are economies ofscale associated with the tion policy. Interestingly, when he compared two pricing investments. The canon of price theory is marginal cost policies (marginal costpricing, andseasonalmargiMalcost pricing. Tn other words, set the price at that point where the pricing) with three non-price policies (leakage control, demand and the supply curves intersect. Unfortunately, metering, and mandated water restrictions) he iound that establishing the r.arginal price for many water uses is the most economically efficient was leakage control, foldifficult because of the characteristics of water that make lowedbymetering and annual marginal cost pricing. AUlof its supplya natural monopoly. The existence of economies the otherpolicies hadnegative benefits. This is an eloquent of scale ensures that those who first entered the market .vill reminder that rationing by pricing is not always the most always be able to underprice and drive out any potential efficient approach. In order to find out, however, it is newcomers. They can decide on their desired prof.. Level inperative to carry out analysis at the level of economic and set the prices accordingly. This fact has been recog- sophistication applied by Hanke. nized for a long time in the area of municipal water and wastewater treatment and the suppliers have been regu- 3A Distinguishing between Generic and lated,typicallybypublicutilitycommissions. Meier(1983) Region-Specific Tsues showed that there are at least five different ways of measuring marginal cost under these conditions, earh The Bank has operations in 152 countries, aggregatresulting in a different estimate of the marginal cost. hi ing them into fourmajarregions. To formulate Bankpolicy practice good estimates can be obtained for most water with respect to water it is essential to distinguish between investmentprojectswith either ofthe approaches currently issues that are generic to the management of water as a used in Bank appraisals: long run marginal cost (LRMC), resource, and others that are specific to individual regions. and average incremental costs (AIC). For example, the difficulty ofmaking "correct" allocation decisions between differentuses orusers is generic towater Unfortunately most regulatory commissions have around tF aglobe, but the relative importance of irigation tended to take a "backwards" accounting stance and allow varies by climatic zone and water availability. The generic pricing based only upon average costs and the revenue issues are the ones for which the Bank needs to evolve needs to meet them: The Bank has operations in 152 countries, aggregating them into fourmajarregions. To formulate Bankpolicy For example, the difficulty ofmaking "correct" allocation decisions between differentuses orusers is generic towater institution-wide policy, the remaining issues can be left to the regional departments.

Traditional rate-setting methods, employed by state regulatory commissions as well as local govemnment agencies, appear to have produced a situation of rapidly deteriorating water systems, both rural and urban, characterized by aging capital facilities and under-maintained water systems. (Mann, 1981) Fourteen generic issues are briefly described and discussed below; nine as broad sector-wide issues (section 4.1), and five as sub-sector issues.

# the 4. Generic Issues of **COnern for the World Bank** nc o e

Thisstanceisnot appropriate insituationswhere the utilities are facing increasing marginal costs (all the be **COnern for the World Bank** projects have been built and now it becomes increasingly nc o e difficult to supply the same amounts of water at the histo i l costs). Under these conditions a "forward" In the water planning community there are several lookingaccounting stance is appropriate. If thispolicywere connections of "water and. . ." which are taken by many pursued, the emphasis on revenue requirements of utilities as paramount relationships that brcok no questioning. As would be replaced by establishing adequate -;re invest- arguedbelow,theBank'sComprehensiveWaterResources met fimds.

In the water planning community there are several Managemedt Policy Paper should take a close look at such