Water Funds: Coase in South America (and New York)

Rivers often create important resource conflicts. Downstream cities want clean water to drink. Upstream residents want to make a living, but that sometimes damages water quality. In the highlands above Quito, Ecuador, for example, residents often convert land to farming and ranching; that allows them to raise valuable crops and livestock, but weakens the land’s ability to naturally cleanse water before it flows downstream.

How can we solve this problem? One response would be for a central government to enact laws and regulations that force the upstream folks to take better care of the watershed. Such laws can play an important role in improving water quality, but they raise several practical concerns. For example, regulatory burdens may place undue economic burdens on upstream residents. And the laws and regulations may be hard to enforce, particularly if local communities view them as an unwelcome burden.

Another strategy is for the downstream water users to pay the upstream residents for keeping the water clean. Such payments can make protecting the watershed into a profit center for upstream communities and can encourage them to accept rigorous approaches to monitoring and enforcement. (In the economics literature, this approach is often distributed as Coasian, in honor of Ronald Coase, who emphasized it in his work.)

Last week Esther and I dined with some officials of the Nature Conservancy (TNC) and learned that they are encouraging exactly this approach to water conservation in South America. TNC is helping create water funds:

Water users pay into the funds in exchange for the product they receive — fresh, clean water. The funds, in turn, pay for forest conservation along rivers, streams and lakes, to ensure that safe drinking water flows out of users’ faucets every time they turn on the tap.

Some water funds pay for community-wide reforestation projects in villages upstream from major urban centers, like Quito, Ecuador, and Bogotá, Colombia. In other cases, like in Brazil’s Atlantic Forest, municipalities collect fees from water users and make direct payments to farmers and ranchers who protect and restore riverside forests on their land through water producer initiatives.

“These ‘water producers,’ as we call them, are being fairly compensated for a product they’re providing to people downstream in Rio de Janeiro and São Paulo: fresh water,” explains Fernando Veiga, Fernando Veiga, Environmental Services Manager for the Conservancy’s Atlantic Forest and Central Savannas Conservation Program in Brazil. “They’re receiving $32 per acre, per year, for keeping their riverside forests standing.”

TNC has an informative interactive graphic that illustrates how it works in the headwaters above Quito. (Note to TNC: the graphic would be even better if it involved less clicking.)

Perhaps needless to say, this idea is not unique to South America. New York City, for example, has been pursuing a related approach, buying up buffer land around the upstate reservoirs that supply the city.