New Study Discusses “An Illiquid Market in the Desert”

Photo Credit: Nêssa Florêncio, Deserto do Atacama, Chile

An Illiquid Market in the Desert

In northern Chile’s Atacama Desert, perhaps the driest region in the world, water allocation is contentious. Groundwater seeps and springs feed isolated wetland areas and indigenous villages reliant on the water for small-scale agricultural production.

Chile has property rights to water, which allow water users to transfer their water like land. Generally, economic research suggests that property rights allow resources to be allocated to high-value uses, creating economic growth. Chile is often viewed as poster child for the benefits of strong property rights, with high incomes and growth relative to other South American countries.

One key driver of Chile’s growth is its mining sector. In the Antofagasta Region, copper production is key, producing a whopping 17% of the world’s supply. In all stages of copper production, water is critical. In the region freshwater for mining is obtained from surface dams and groundwater pumping in the Andean highlands above the seeps and wetlands. Water rights purchases and extractions by mining firms have reduced water tables and surface flows, leading to declines in arable land and wetlands.

Map of northern Chile’s Antofagasta region. Notes: Authors’ drawing with data from ESRI and Red Hidrográfica; City and mine location information coded by the authors.

While Chile’s water code generally allows for unregulated trading of water rights, growing incomes have increased demand for environmental amenities, which are not well defined in the private water right system. In addition, initial water right assignments were perceived as unfair by indigenous communities already using water, and their claims remain largely unresolved. Starting in the mid-2000s, the water regulator addressed these concerns by rejecting applications to transfer water use from agriculture to mining.

In a study that comes out this month in Environment and Development Economics, myself, Gary Libecap, Gonzalo Edwards, and Oscar Cristi estimate the direct cost of the policy to restrict water trades. Mining firms, which initially purchased water rights from agricultural water users have responded to the trade limits by shifting water input to the desalination and pumping of seawater as far as 150 km (93 miles) to altitudes over 3,000 m (9,800 feet) above sea level.

The cost of desalinated water is substantially higher than the observed market price of water in local agriculture, and the generation of energy for both desalination and pumping releases greenhouse gases. We estimate the direct policy costs at US$52.5 million per year, which may be large or small, depending on what benefits, and to whom, these costs are compared to. Comparing the policy cost to total agricultural output in the region of only US$6 million annually suggests the cost is large. So too is the implied policy cost of over US$74,000/year for each active indigenous agriculturalist in the region.

However, the direct value of agricultural production is likely to underestimate the importance of water to indigenous communities. Benefits of the policy include cultural values associated with indigenous water use, avoided relocation costs, and agricultural production. The policy serves to partially protect highly valued tourist destinations, including the Los Flamencos National Reserve near the city of San Pedro de Atacama.

Unfortunately, the policy may also harm the environment, albeit in a different way. Desalinating and pumping water results in an additional 721,451 metric tons of CO2 emissions. At the rate economists estimate carbon emissions damage the global environment, this pollution costs an additional US$31.0 million per year.

While unregulated water transfers led to concern over damage to local environmental and cultural amenities, the new policy is also costly, potentially even to indigenous communities. The Chilean government has purchased water rights and then granted them to communities in perpetuity. However, once these rights are locked in place, they lose much of their value as a financial asset because they cannot be sold to mining firms. Thus, although communities can use the water, it has limited direct financial value due to low agricultural productivity.

We suggest firms could use the commitment process stipulated by the Chilean Undersecretary of Mining for indigenous relations, aimed to protect natural heritage and water flows, to determine to what extent village and mining water needs could be met mutually. For instance, if mining firms worked with communities on the location and amount of water diversions. Second, indigenous villages could be compensated, for instance investment in infrastructure and education, in addition to the payment firms make to water right holders.

Going forward, policy makers and regulators face a dauting challenge in balancing the policy and environmental costs of trade restrictions against high cultural and intrinsic values placed on keeping water flowing as it traditionally has. Northern Chile’s aridity and mining sector make freshwater in the region some of the most valuable in the world. Other arid regions facing increasing scarcity can take lessons from the tradeoffs Chileans have faced.