Incentive pricing for irrigation water with information asymmetries

In accordance with the European Water Framework Directive (WFD), the management of water resources should be delegated to appropriately established local bodies, referred to as River Basin Districts (Bogaert 2012). Basin Districts are responsible for the full cost of water usage in order to ensure the good hydrological status of the territory under their jurisdiction. Such costs should then be transmitted to end users through appropriate (higher) tariffs. The existence of economic tools, that enable local water authorities to allocate costs among users and to control water uses in accordance with the WFD principles change considerably depending on several factors. Lack of metering is the main constraint. This condition hinders the ability to monitor volumes used and to promote volumetric pricing as a way to allocate costs and to ensure efficient water use (Viaggi et al. 2010; Johansson et al. 2002; Smith and Tsur 1997; Bowen and Young 1986). This issue is a challenge especially for the agricultural sector since the most common delivery system for irrigation water worldwide is open canals (Bogaert 2012). Here, the presence of a heterogeneous population of farmers poses implicitly the two typical problems of asymmetric information: a) adverse selection, due to the non-observability of a farm’s type and its technology; b) moral hazard, due to the non-observability of a farm’s actions, such as the actual use of irrigation water (Viaggi et al. 2011).