1960s. The above-cited bookbyKneese and Bower (1968) ri .. ; ween different uses of water. For example,in is still a leading text on the economics of water qtaiity. the EMENA region the opportunity cost of water in Ihr municip al secte. is at least two to three times as high as the The concernofeconomists analyzingwaterpollution marginal val'e of irrigated agricultural proCaction per is with "market failure. " In particular the issut of how to cubic meter of water for all crops except some vegetables intemalize the e..emalities has received most ofthe atten- (tomatoes and cucumber). However, when the inigation tion. At the most obvious level it would seem that if the projects are evaluated by themselves, without considereffluent could be correctly piced, then industry and other ation of the opportunity cost of water in other sectors, they polluters could be taxed by just this amount and problem appear to have acceptable Internal Rates of Retum (IRR). would disappear - the correct amount of pollution would be obtained, and if this were cons'dered too large then the Similarly, the externalities due to envi.inmertal effluentpricecouldberaiseduntilasatisfactorylowerlevel damages are not integrated into the appraisal of projects. of pollution was achieved. The economic principles dre clear, but little attention has been devoted in the pas to evaluating the damages and Coase (1960) showed that externalities by them- therefore they tend to be overlooked in the analysis. selves do not lead to economically inefficient solutions provided that the polluters and the people being affected 2) The theory needs refining. can freely and inexpensively negotiate with each other. Coase claimed that the responsibility for damages is a No theory is perfect, and so it is with the theoretical reciprocal one, with the affected party taking steps to avoid approaches to water resources management. The relevant them as much as the perpetrator takes steps to avoid question is how the imperfections inthe theoreticalunderproducing them. Economic efficiency is achieved when pinnings lead to unacceptable outcomes from the point of extemal damages are borne by the party that can most view of the Bank, other funding agenc,es, and governcheaply repair them. ments. There are several assumptions about the theory that cause difficulty in water plannirg, but there are also Hufschmidt and Dixon (1986) have extended envi- approaches to softening or eliminating these market failronmental economics to the issues faced in developing ures from the conceptual model. Three areas stand out as countries, particularly with respect to water projects. Pa- causing more trouble than others and, hence, may need pers by Devousages and Smith (1983) and by Fisher and more refinement of the theory. Raucher (1984) show how contingent valuation methods can be used to evaluate the benefits (and damages) associA. _The difficulties associated with making_ ated with a wide range of environmental impacts that _macroeconomic allocations between investmnents inwaterallocations between investmnents inwaterinwater_ hitherto had been thought to be non-measurable. In the _resources and other economic sectors. and other economic sectors. other economic sectors._ The pervasiveness Policy Paper the Bank should pursue this line of thinking ofwaterusethroughouttheeconomymaypartiallyexplain and layoutthe appropriatetmethodologiesforassessingthe the first problem, but other sectors, including energy, economic dimensions as well as the non-economic dimen- radiate similar pervasive connectinns throughout the sions of environmental deterioration.

A. _The difficulties associated with making macroeconomic allocations between investmnents inwaterallocations between investmnents inwaterinwater resources and other economic sectors. and other economic sectors. other economic sectors._ The pervasiveness economy and society. Water plannin, zmas been an integral part of governmental planning for much longer than other resource sectors. Hence, large andpowerful interest groups are fully cognizant of their stakes in planning. In most activities;indeed,theideaofsuchbalancingisthreatening to groups with a vested interest in water investments and odology to relate water sector plans to the overall macro development ofa country is a generic problem that should guide investments and other Bank water activities.

# 3.3 How the Froblems Can Be Resolved

There are two possible, and not mutually exclusive, countries it is not of particular concern that the water explanations of why problems arise in the way water planning and investnents be balanced with other sectoral resources are planned, appraised, and implemented. activities;indeed,theideaofsuchbalancingisthreatening to groups with a vested interest in water investments and 1) The accepted economic principles are adequate management. The development ofreliable planning methbut the application is inadequate. odology to relate water sector plans to the overall macro The appraisal approaches used at the Bank and at guide investments and other Bank water activities. other funding agencies are based upon the generally accepted principles outlined voluminously in the literature B. _Dealing with externalities directly in the analysis_ referred to above. The application of the principles is (internaizing _the externatides)._ Dealing with externalities flawed because, when faced with economic scarcity, the directlyinthe appraisalmethodologyis another important water itself must be priced at its opporunity cost. This is requirement. The theory and methods for doing this have typically not done and leads to serious misallocation of been developed and many environmental consequences 7