Appendix A: Water Resource Management and Allocative Efficiency
Allocative efficiency is often summarised as an outcome where resources are utilised in a way to maximise contribution to the economy as a whole. However, a more thorough understanding is required to describe why a National Cost Benefit analysis might be undertaken, and the reasons for assumptions that are made in the process.
McTaggert et al (1996) describes allocative efficiency as the outcome "where no resources are wasted - no-one can be better off without someone else being worse off". This concept is also known as Pareto Optimality (Tietenberg, 1988).
There are considered to be three conditions to support Pareto Optimality, they are (from McTaggert et al., 1996):
- Economic Efficiency: This condition requires that the resource be used in a way that maximises its value to the economy. It is generally accepted that economic efficiency is achieved in a situation where individual firms maximise profit from their use of the resource.
- Consumer Efficiency: This condition is met where the allocation structure ensures that consumption is maximised through response to market signals. For example, if it were assumed that all water is allocated to hydro-generation, and that agricultural production prices were inflated domestically, this signal might translate to reallocating the water towards irrigation, rather than hydro-electricity provided entry costs to resource use could be overcome.
- Equality of Marginal Social Cost and Marginal Social Benefit: This condition is important to capture the "externalities" that might arise with alternative allocation strategies. Marginal social costs represent the total costs that are realised by the producer or consumer, as well as those borne by other members of the community as a result of changes in resource use. Similarly, marginal benefits represent the total costs that are realised by producer or consumer, as well as those borne by other members of the community. This is criteria is often used to describe the outcomes upon the environment, social and cultural attributes as well as diffuse productivity impacts not captured in markets.
Kaldor-Hicks efficiency is sometimes considered a less stringent version of Pareto optimality (Counsell, 2003) where marginal social benefit attributed to one group is greater than the marginal social costs realised by another group. This technique seeks to address situations where separate sectors of the population realise benefits or costs for a given proposal, and overall assessment is required. It should be noted that not all situations of Kaldor-Hicks efficiency represent satisfaction of the Pareto Optimality criterion, and vice-versa.
The process of allocation (including the structure of consents) should seek to identify opportunities where existing allocations can be re-organised to maximise economic value from the water resource that have no external costs and benefits. If such opportunities are exhausted, analysis of the marginal social costs and benefits becomes a necessary component before increasing allocations above current allocation levels or facilitating re-organisation of existing rights.
The basic question to be asked with regard to the lower Waitaki River is whether the aggregated marginal social costs of reduced flows in the Waitaki River are less than the aggregated marginal social benefits of increased irrigation and/or hydroelectric generation.
In the upper Waitaki Catchment (above Waitaki Dam), the question is the appropriate re-allocation of water, while trying to understand the implications for aggregated marginal social costs and aggregated marginal social benefits of potential outcomes from re-allocation.
One of the major concerns at a regional level is that the location of the marginal social costs and benefits will result in overall negative outcomes for some regions and overall positive outcomes for the remainder. A national cost benefit analysis is not structured to recognise the economic inter-relationship between regions, and this report does not aim to summarise the outcomes for specific regional areas. It is understood that this information will be provided in other reports to inform the water allocation framework.
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