Price & Quotas in the Israeli Market for Irrigation Water: A Political Perspective

Israel FinkelshtainThe Hebrew University

Iddo KanUniversity of Haifa

Yoav KislevThe Hebrew University

Regulating Water Use By Law and in Practice Regulating Water Use By Law and in Practice

Law: Law: Israeli “Water Law” (1959):

I. In regions where Demand > Supply, water use is regulated by quotas.

II. The regulator may levy the users to recover pumping and delivery costs. That is, the “administrative water price” is a vehicle to recover cost.

Practice: Starting from the mid eighties, large proportion of Israeli farmers apply less water than allowed by their quotas. For these farmers, the value of marginal production of water at their quota is below the administrative price.

Unplanned Regulation Reform Unplanned Regulation Reform

Settlements Consumed More than 10% of Quota

0

10

20

30

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70

1984 1986 1988 1990 1992 1994Year

%

KibutzesMoshavsMinorities

Agricultural WaterConsumption versus Quotas

600

700

800

900

1,000

1,100

1,200

1,300

1,400

1,500

1,600

1970 1980 1990 2000Year

106 c

m/y

ear

ConsumptionQuotas

Lobbing in the Israeli Water EconomyLobbing in the Israeli Water Economy

•• Water Committee of theWater Committee of the Israel’s Farmer’s Federation(farmers(farmers’’ lobby) lobby) -- Main Targets: 1) Hindering the price Main Targets: 1) Hindering the price raise of irrigation water, 2) Securing Water Quotas/Rights.raise of irrigation water, 2) Securing Water Quotas/Rights.

•• Chair of GrowersChair of Growers’’ Association in a Parliament Discussion: Association in a Parliament Discussion: ““We have a strong Agricultural Lobby,We have a strong Agricultural Lobby,……, we fought on the , we fought on the water pricewater price…”…”

•• Perez (1999):Perez (1999): 1) Evidences for political discrimination 1) Evidences for political discrimination between sectors (between sectors (KibuzimKibuzim, , MoshavimMoshavim and Minorities); and Minorities); 2) Evidences for political pressure 2) Evidences for political pressure -- negative effect of price negative effect of price on quotas.on quotas.

•• ZusmanZusman (1997): explains block rate pricing as a mechanism (1997): explains block rate pricing as a mechanism to mitigate political pressure to hinder price raise. to mitigate political pressure to hinder price raise.

An Intriguing ObservationAn Intriguing Observation

From 1975 to 2002 Terms of Trade (Agricultural-Products-Prices / Water-Price) were declined 6 times.

Terms of Trade(Agricultural-Products/Water; 1952=100)

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1970 1980 1990 2000

Year

%

From 1975 to 2002, real water price has tripled.

In the same period prices of agricultural products have declined by more than 50%.

Price Indices(1952=100)

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Agr

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Water

Agricultural ProductsWater

ObjectivesObjectivesTheoryTheory

• Characterizing the equilibrium of the water economy, taking into account the political lobbying.

• Welfare analysis: ranking intervention regimes (quotas, prices and mixed regime).

EmpiricsEmpirics

• Estimating: 1) the “weight” that politicians attach to society’s welfare relative to the welfare of interest groups; 2) effectiveness of farmers organization for lobbying .

• Simulating: 1) the welfare consequences of alternative intervention regimes; 2) the effect of exogenous changes to explain the sharp price hike.

The ModelThe ModelWater SupplyWater Supply

CC((WW)) represents total cost of pumping and delivering the water represents total cost of pumping and delivering the water including environmental damages, intergenerational external costincluding environmental damages, intergenerational external costetcetc’’. . WW is the total water supply for all users is the total water supply for all users -- irrigation, industrial irrigation, industrial and urban uses. It is assumed that the marginal cost (MC) is nand urban uses. It is assumed that the marginal cost (MC) is nonon--decreasing in decreasing in WW, , CCWWWW≥≥0 0

FarmersFarmers

Utilize water for irrigation; heterogeneous in the value of marginal production of water (VMP), πw(w,α), where w denotes applied water and α a parameter that represents technological heterogeneity with distribution G(α) on some interval.

The Model (continue)The Model (continue)GovernmentGovernment

Sets individual quotas, q, and an administrative price, p, to maximize a weighted function of social welfare, U(q(α)), and the welfare of organized interest groups, Uo(p,q(α)).

The micro foundations for this objective are provided by:

1. Zusman (IER 1976) who described government policies as a Nash solution to a bargaining between lobbies and politicians,

2. Grossman and Helpman (AER 1994) who characterized policies as a Nash equilibrium in a menu auction game,

3. Finkelshtain and Kislev (JPE 1997) who portrayed policies as an efficient contract between lobbies and politicians.

In all 3 approaches, lobbies formation is exogenous.

Social Welfare U(w)

ps

W

D(W)

CW(W)

Socially Optimal Water Allocation

w

p

πw(w,αh)

πw(w,αl)

whwlql qh

ps

Political Economic Equilibrium• The government posts an initial water price and a quota is

allocated to each farmer. Two groups are formed: Nq

farmers find the quotas binding and lobby for larger quotas.For the rest Np farmers, the quotas are non binding and the administrative price determines their water application.

• Some farmers (from both groups) may be organized in a lobby for a lower price. Due to the public good nature of the lobbying for lower prices, it is expected that the organization would be incomplete.

( )( )( ) { ( )( )

4342143421

WelfareFarmersOrganized

o

ParametrEthicalWelfareSocial

qpqpUqUG

',

,max νβνν

×+=

• The ensuing quotas and price maximize the weighted objective function of the politicians:

w

p

Three Possible Equlibria

}N q ( )pi ˆ>ν

N p ( )pi ˆ≤ν

p̂

νν

νν ν

ν

ν

Separating EquilibriumPooling-Price Equilibrium

N p ( )pi ˆ≤ν}N q ( )pi ˆ>ν

Pooling-Quotas Equilibrium

Properties of the 3 Equlibria1. Separating Equilibrium: For the Nq more “productive”

farmers, MC>VMP>p. For the Np less “productive”farmers, MC>VMP=p. Over utilization of water and an additional source for welfare loss - inequality of VMP between groups.

2. Pooling Quotas: Over utilization of water, MC>VMP, welfare loss, but no intra-farm inefficiencies, the “political arena” replaces the market in ensuring uniformity of VMP among farmers.

3. Pooling Price: Over utilization and welfare loss, MC>VMP=p.

Exogenous Changes in Separating Equilibrium• Higher Ethical Norms (smaller β) reduce quotas, increase equilibrium price and social welfare.

• Decline in Terms of Trade, reduce quotas, increase equilibrium price and reduces water use.

• An increase in Supplying Cost, reduce quotas and increase equilibrium price and reduces water use.

• A decrease in the # of farmers with binding quotas (Nq), reduce quotas, increase equilibrium price and increase welfare. It is important to note that this number is controlled by the regulator.

Ranking Equlibria• In general, depends on both irrigation technology and political organization.

• With relatively large elasticity (close to 1) of water demand, pooling price is the most efficient regime from the perspective of social welfare.

•In other cases, a detailed empirical research is required.

Empirical Analysis for Israel, Mekorot prices, 1985-8Pricing system of Mekorot waters

Prices are set by the government based on Mekorot’s sub-facilities. Quotas are allotted to settlements.

DataA panel of 538 settlements at 32 regions in 1985-8.

Estimation Procedure1. Estimating a linear agricultural water-demand function in the

settlements level.2. Calculating the regional VMP of those who are bounded by their

quotas (the Nq group), .3. Estimating the political factors: β, and the level of organization for

lobbying for a lower price, φ.

θπ w

Estimating Demand Functions in the Settlements LevelN = 1,427 (Mekorot-only consumers), Np = 789, Nq = 638, 1987 NIS, Log likelihood = -5858.

Average price = 0.150 NIS/cm, Average consumption of Np settlements = 526 (103cm/year), Elasticity of the Np settlements = -0.70.

251.9σ0.022.332,554.0Constant (103cm/year)

0.056-1.91-29.539Terms of Trade Index0.587-0.54-0.299April Rain (mm/month)0.68-0.41-0.167October Rain (mm/month)

0-8.74-0.286Altitude (meters)05.13147.1South (dummy)

0.0491.9734.4Center (dummy)0.176-1.35-27.320Moshavim (dummy)

0-3.5-160.6Minorities (dummy)03.990.746Flower (dunams)

0.7510.320.002Field (dunams)08.980.187Vegetables (dunams)06.30.102Plantation (dunams)026.080.539Quota (103cm/year)

0.001-3.44-2,460.2Price (NIS/cm)P>ttCoefficientVariable

Estimating Regional Scale Political Factors

8.5=β 85.01

=+

→β

β

Nationwide average β

( )( ) jtjtw

qjtN jt

pjtjt

pjtjtjt

jt NpNNpc

jtβπα

φ θ∑ −−

−=

Rate of organization for lower price, φ

jtjtw

jtwjtjt p

c−

−= θ

θ

ππ

β

Politicians’ ethical level, β

13.0=φ

Nationwide average φ

• Mitra (2006) – Recent empirical studies estimate φ to be more than 40 times higher than .β

β+1

0.08384720.080Pooling-quotas

0.037249-0.27Pooling-price

0.05173570.190.15Separating

Welfare-loss(NIS/cm)

Welfare-loss(106 NIS/yr)

Q(106 cm/yr)(NIS/cm)

p (1987)(NIS/cm)Equilibrium

θπw

Simulating Political EquilibriaSimulations

Explaining the Price HikeInitial results indicate that the most important factors in explaining the price hike are the sharp decline in the output prices and the increase in supplying costs. A minor factor is the weakening in the farmers’ lobby political power.

Price Indices(1952=100)

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Water

Agricultural ProductsWater

Thank You for Thank You for Your AttentionYour Attention

w

p

Two Groups of Farmers

( )hhw

h q απν ,ˆ≡

hq̂lq̂

lν

lw=

}N q ( )pi ˆ>ν

N p ( )pi ˆ≤νπw(w,αl) πw(w,αh)

hw

p̂

ν

νν

νν

w

p

Separating Equilibrium

}N q ( )pi ˆ>ν

N p ( )pi ˆ≤ν

p̂

MC=ps

θπ w

p