Discussion Paper No. 75: Hatzius, Thilo: Market and Non-market Failure in Path Dependent Institutional Reform. The Case of a New Water Fee System in the Republic of Macedonia

Diskussionsschriften Nr. 75 der Forschungsstelle für Internationale Agrar- und Wirtschaftsentwicklung eV, Heidelberg, September 2000

The author is a free lance consultant, formerly senior researcher and now affiliated with the Research Centre for International Agrarian and Economic Development (FIA), in Heidelberg, Germany. Correspondence should be directed to the Research Centre for International Agrarian and Economic Development (FIA)


1Introduction 3

2Market failure, non-market failure and path dependency - some specifications 3

3Issues of institutional reform in the Macedonian water economy sector 5

3.1 The Public Water Economy Enterprise and it’s regional branches: transitory or design immanent incentive problems? 48

3.2 The lack of a consistent National Water Policy: lack of financial and human resources or lack of political will or a case of non-market failure? 48

3.3 The precarious situation of irrigation agriculture: temporary or permanent, external or internal incentive problems? 48

3.4 Financing water related goods and services: royalties or levies, service fees or taxes, subsidies or cross-subsidisation? 48

4 An institutional approach to water pricing - some theoretical concepts 48

4.1 Institutional imperfections and failures 48

4.1.1 Market failures and the narrow perspective of neo-classical economics concentrating on price incentives 48

4.1.2 Non-market failures and non-price incentives - the extended institutional perspective 48

4.2 Intrinsic properties of goods and resources and the demand conditions of water and water related goods and services 48

4.2.1 Private, public and mixed goods 48

4.2.2 Supply and demand aspects of water and water related goods and services 48

4.3 Institutions for providing, financing, operating and maintaining irrigation infrastructure 48

4.3.1 Rules for providing and financing irrigation projects 48

4.3.2 Governance modes for O&M services in irrigation 48

5 Current issues of institutional reform in the Macedonian water economy sector - some conclusions 48

5.1 The organisational set-up of PWEE and WMO and the situation of irrigation agriculture 48

5.2 The national water policy and the financing of water related goods and services in the water economy sector 48

References 48


CPRCommon Pool Resource

EUEuropean Union

GTZDeutsche Gesellschaft für Technische Zusammenarbeit

ICIDInternational Commission on Irrigation and Drainage

IIMIInternational Irrigation Management Institute

IRRPIrrigation Restructuring and Rehabilitation Project (World Bank)

JICAJapan International Co-operation Agency

MAFWEMinistry of Agriculture, Forestry and Water Economy

NGONon-Governmental Organisation

NPENew Political Economy

NWLNew Water Law (of 1998)

O&MOperation and Maintenance

PWEEPublic Water Economy Enterprise

PWFPublic Water Fund

SCBASocial Cost Benefit Analysis

UNUnited Nations

WDIWater Development Institute

WMEWater Management Enterprise

WMOWater Management Organisation

WMWOWater Management Working Organisation

WUAWater User Association


Republic of Macedonia, Southeast-Europe, water price system, path dependency, institutional reform, natural resources management, institutional economics, transition countries, water economy sector reforms


Macedonia with a population of about 2.2 million only gained it’s independence from Yugoslavia as recently as 1992. Institutional reform in the water economy sector of Macedonia is a particularly complex and urgent problem area. Complex - because of the predicament stemming from it’s geographical location, from the uneven spatial and timely distribution of water in the country, and from it’s very particular geo-morphological, historical, political, religious, ethnic, and, consequently, economic situation. Urgent - because Macedonia’s economy and it’s agricultural sector in particular is in a precarious state. The importance of agriculture in terms of agricultural population has decreased from 72% to 12% in the years after World War II. In terms of the trade balance there have been extreme variations, a function of the changing political situation within the country and outside, the UN trade boycott against Yugoslavia, the temporary boycott by it’s southern neighbour Greece and recently the war in neighbouring Kosovo being the more important negative factors. Between 1990 and 1995 the share of agriculture in total trade varied from 7 to 17%. In terms of water used, about 62% of the total of 1.846 mill m³ water consumed in 1996 went to the agricultural sector, with an additional 11% going to fish ponds. 11.6% have been used for municipal water supply, 14.8% for industry. Of the arable agricultural area of 665.000 hectares about 400.000 have a potential for irrigation, 123 100 ha have irrigation infrastructure in some form or other - but only 36 146 have been irrigated in 1999.

The paper analyses some of the reasons for the decline in irrigated area which is explained to be transitory and related to failing markets and non-market institutions, path dependency, design problems in formal institutions and time lags in the adaptation of informal institutions to the changes in formal ones. The result is an inadequate incentive structure for stakeholders, the principal ones being public sector institutions, the public water economy enterprise, the regional water management organisations (WMO) with the people working therein, and, last not least, the farmers. The insufficient organisation of irrigation farmers, the decreasing propensity of farmers to pay the ever increasing fees for deteriorating services of the WMO, and the bad state of irrigation infrastructure are identified as central causes and effects at the same time, resulting in a vicious circle which is hard to get out of. Some features of the institutions decreed by the New Water Law of 1998 leading to a re-centralisation of the Macedonian water economy sector and the creation of the Public Water Economy Enterprise are seen to go against the insights gained in recent years by development practitioners and academics working on water resources management. The paper, after defining four principal problem areas, applies concepts of neo-classical and new institutional economics to develop elements of a conceptual framework for the design of an appropriate institutional configuration for the water economy sector and a corresponding new water fee system. In it’s concluding section some tentative answers are given to the questions asked in the first one, the central conclusion being that institutional design and it’s implementation in the case of the Macedonian water economy sector is a path dependent process of trial and error rather than a straightforward blueprint affair, requiring much patience, flexibility and innovative capacity of the people involved.

1 Introduction [1]

The transition from a centrally organised to a decentralised market economy is a complex process. The pace of this transition has certainly been overestimated in the case of most Eastern European countries. Private investors with their own capital at stake as well as policy advisors involved in assisting governments in the revision of the institutional framework and in the design of policies promoting structural change are increasingly concerned about the limited positive impact reforms have had on the performance of markets and of public, semi-public and private organisations, on the performance of the economy, on the political and social situation in these countries and, consequently, on the well-being of it’s people. The question if institution sequencing and timing might have something to do with this outcome is therefore a relevant and urgent one.

The title of the symposium, on the other hand, suggests a rather traditional approach to economic policy, which assumes the goals in terms of a social welfare function to be known, the basic structural relationships of the economy well understood and a set of tested and controllable policy instruments and measures at hand allowing a high degree of certainty with respect to the outcome. In our particular case, this would mean a set of institutions and organisational arrangements leading, if properly applied and sequenced, to effective and efficient transactions among actors within markets and within organisations, to the elimination of inefficient institutional arrangements, to prosperity of the economy and to long lasting economic growth. This concept of economic policy might be in the back of our minds -of the participants of this symposium, of decision makers in the governments advised, and of policy advisors themselves. The author of the present paper is less optimistic. By showing some of the complexities involved in his particular case he might be able to justify this opinion and, at the same time, contribute some elements to the discussions of this symposium and those necessary in Macedonia, where the process of creating a new water fee system is still going on.

2 Market failure, non-market failure and path dependency – some specifications

The terms market failure, non-market failure and path dependency mentioned in the title of this paper refer to central issues in institutional reform and require some further specification. Market failure is a widely used term and well-known concept in mainstream economic theory. New institutional economics, however, has an extended understanding and research agenda of institutional failure which includes both market and non-market failure . The latter term refers to failures within non-market institutional configurations, organisations or governance structures. A first type of non-market failure is inherent in state and non-profit organisations usually financing their activities from financial transfers not earned in the market. As a consequence, they lack competition, the much praised efficiency enhancing mechanism inherent in this institution. A second type of non-market failure is due to asymmetrically distributed information leading to strategic behaviour of economic agents and to the corresponding phenomena of shirking, moral hazard and adverse selection also present in private market and profit oriented firms. These failures lead to high transaction costs and inefficient and ineffective outcomes. Development and resource economists have gratefully taken up these concepts as they explain, at least verbally and sometimes illustrated with simple game analytic models, phenomena and facets of reality which are particularly relevant for the subject matters they are dealing with. Neo-classical economists, excluding some of these facets, on the other hand, have the practical tools and problem oriented methodologies at hand leading sometimes to more straightforward (and perhaps too simplistic) answers for policy makers. Both, however, have their merits and both theories will be referred to in this paper.

The term path dependency is applied in different ways by economists and other social scientists. Some of the corresponding concepts seem to be relevant to the question of institutional choice, timing and sequencing and the water economy sector. In neo-classical economic theory path dependency sometimes refers to problems of asymmetries in the reaction of some economic variables to changes in certain other ones, usually prices, where different effects result, depending on the direction of the (price) change. The term is also used in the context of an investment in ‘lumpy’ infrastructure. The high initial costs create path dependency for subsequent decisions because of a high fixed cost component [2] . Investments in infrastructure for the provision of water storage and distribution structures often have this characteristic – mainly for technical or economic reasons in order to take advantage of economies of large scale production and provision of services [3] . This latter case is referred to as ‘natural monopoly’ because access for competitors is restricted or impossible and thus effectiveness and efficiency enhancing competition absent. Special care is therefore needed in setting the right incentives in the design of institutions in this particular case. The provision of infrastructure by public entities and marginal cost pricing, e.g., both generally assumed to be straightforward solutions to the provision and financing problem, are often neither needed nor recommendable and sometimes not even possible [4] .As will be shown in the second section of the theoretical part of the paper, the intrinsic properties and the demand and supply conditions of the goods involved give indications as to an efficient and effective way for their provision and financing.

For evolutionary and new institutional economists , on the other hand, path dependency refers to the historical dimension of institutional change, to irreversible self-enforcing tendencies resulting from ‘network-externalities’ and ‘learning-by-using’, to cultural factors and to lags in the adaptation of informal institutions to formal ones as well as to time lags in the adjustment of perceptions of stakeholders [5] . In case these adaptations and adjustments do not take place the way assumed, the incentives and opportunities brought about by changes in formal institutions will not positively influence the behaviour of stakeholders but rather lead to adverse effects on efficiency, on the distribution of assets and income as well as on economic growth and, as a consequence, on the social and political situation of the countries or sectors concerned.

This phenomenon can also be observed in the case of the Macedonian water economy and particularly in the irrigation sector. The New Constitution, the New Water Law (NWL) and institutions specified therein, including the ‘new water fee system’, give a formal institutional set-up which has, to a large extend, not yet been implemented and thus has not led to the expected positive adaptations of informal institutions, peoples perceptions and behavioural patterns. The design and introduction of a new water fee system is part of this general implementation problem and thus cannot be seen in isolation from the whole process of institutional transformation. The paper therefore will include some general issues concerning inconsistencies in the NWL and deficiencies inherent in the general institutional configuration of the water sector specified therein. It will need to be discussed with policy makers and stakeholders within the water economy sector.

The four sections in the first part of the paper will refer to current issues of institutional reform within the Macedonian water sector. The titles are formulated as questions to which the concluding section of the paper will give some tentative answers. These answers are partly derived from the insights gained in the second part of the paper. The titles of the three sections of this theoretical part refer to strategic ‘Is’ considered important for institutional reform of any water economy sector: ‘ Institutional imperfections and failures’, ‘ Intrinsic properties of water and water related goods and services ’, and ‘ Institutions for irrigation provision and financing’.

3 Issues of institutional reform in the Macedonian water economy sector

3.1 The Public Water Economy Enterprise and it’s regional branches: transitory or design immanent incentive problems?

The central problem of the Macedonian water economy sector at the moment is the rapid deterioration of the financial situation of 24 regional Water Management Organisations (WMO) [6] now to be considered regional branches of the Public Water Economy Enterprise (PWEE). The PWEE was founded in 1998, based on Article 137 of the New Water Law (NWL) of the same year. Creating such a public sector enterprise has to be seen as a consequence of the New Constitution changing water from a socially to a state owned natural resource. According to the NWL, the WMO should only perform tasks of public interest assigned to the PWEE [7] and the latter should be organised according to the Law On Public Enterprises. In reality, however, WMOs are still working as separate decision-making units under the Law on Associated Labour of 1976 and the Law on Enterprises of 1988, allowing them to work as Water Management Working Organisations (WMWO), Water Management Enterprises (WME) and Limited Liability Companies. This is reflected in a sometimes incoherent mixture of activities, some profit oriented some others of public interest. Their accounting systems do not have a unique account plan. Accounting systems only satisfy the legal requirements of historical record keeping and tax collections and are not designed as a management instrument. To date accounting systems in most WMOs do not allow to distinguish activities losing money from those gaining money. They do not allow to determine which activities are cross-subsidising others, nor do they allow to calculate cost centre specific full costs, a precondition for the calculation of real cost based water fees.

In the past, water fees have been oriented in covering the ever increasing general losses with no relation whatsoever to real costs nor to the marginal value product of water in agricultural production or to user’s ability to pay [8] . This has led to a vicious cycle of decreasing recovery rates, decreasing quality of irrigation services, decreasing agricultural land irrigated, increasing liquidity problems, further increasing water fees etc.. An unofficial report on four pilot schemes supported by the World Bank states that “all four WMOs recorded a net loss for 1999. For three of them the ratio shows a worsening situation, compared with the previous year, while the one which recorded a relative improvement in performance ... still had a net loss of nearly 50% on sales” (Lee, 2000: 9).

On the water demand side, the situation might be explained in terms of the general crisis of the economy, the almost complete elimination of subsidies in the agricultural sector and the deteriorating market production and cash income of farmers; on the water supply side the situation might be explained by the deteriorating physical capital which lacks maintenance, reinvestment and modernisation leading to high costs, inefficient, untimely and low quality water provision services. In terms of institutional failures some explanations would be the difficulties in the start-up of the new public enterprise, the lack of, or wrong incentives for stakeholders on the demand and supply side, the lack of management experience of PWEE and WMO staff and of inadequate management tools. These problems might temporarily be solved by the injection of financial capital, by training and up-grading of personnel. In the medium and long run, however, only an appropriate institutional configuration will guaranty institutional sustainability avoiding as far as possible the evident incentive problems caused by non-market institutional failures.

For institutional economists and sociologists, on the other hand, the situation is a case of gradually deteriorating social capital. Sociologists [9] will note the general loss of trust between stakeholders, between farmers and WMO personnel, between employees and staff members, between civil servants on the local and on the central levels. Institutional economists, on the other hand, will point to the lack or the wrong incentives within an incoherent institutional configuration, of asymmetrically distributed information leading to shirking, moral hazard and adverse selection. These non-market failures and agency problems will be treated in the first section of the theoretical part of the paper.

3.2 The lack of a consistent National Water Policy: lack of financial and human resources or lack of political will or a case of non-market failure?

The most important water user within the Macedonian water economy sector is the agricultural sector, the same as in most other countries and particularly in the developing countries of the tropics and sub-tropics. Estimates for 1996 show that the irrigation sector used about 62% of the total demand of 1.846 mill. m³ water with an additional 11% going to fish ponds. Industrial use of different kinds accounts for 14.8% and the municipal water supply for 11.6% of total water demand (ICID, 1999) [10] . As in many other countries, official documents do not point out acute shortages of water for the time being. Considering spatial distribution and seasonal patterns, however, there are indeed indications of declining water levels of lakes and water shortages in most municipalities. Even conflicts over water are not impossible in the medium and long run, as most lakes as natural water reserves are shared with neighbouring countries [11] .

The shortages observed are bound to become more acute in the years to come because of an increasing demand in most sectors of the economy. The demand for ecological uses and for tourism is becoming a new concern, particularly in view of European integration where ecology and bio-diversity related issues are high on the agenda. Also tourism has a high potential once the region will be back to normality. Once the structural transition will show it’s impact in terms of growing production and incomes also the traditional uses such as drinking water, agriculture and industry will show increasing demand. Last not least, not just water quantity but particularly water quality will be a limiting factor and thus an important issues in national water policy [12] .

Though still not well articulated and officially acknowledged in a national water policy document, there are concerns about water shortages and environmental problems, in documents translated into English, e.g. in the ‘National Vision Water for Food and Rural Development 2025’ (ICID, 1999 ) and in the ‘Study on water resources development and management master plan‘ (JICA, 1999) quoted before. These, however, lack official recognition, wider distribution, analytical depth and policy orientation. The efforts by the GTZ ‘umbrella’ project [13] to foster the elaboration of a Water Master Plan in a comprehensive participatory and policy-oriented process involving the public, semi-public entities assigned specific tasks by the NWL, on the other hand, have been delayed. It is not quite clear, which factors have blocked these efforts most, the change in government, the lack of human, physical and financial resources within the Ministry of Agriculture, Forestry and Water Economy (MAFWE) and the water economy sector, the interests of stakeholder not interested in transparency and clearly spelt out rules of the game, or the lack of political will. The latter term, of course, an empty slogan often heard, but generally only blurring vision for more profound reasons. One of these is the weak social capital factor, indicating deficiencies in the co-operation capability of the society. With respect to a new water fee system, for the time being it is unclear and doubtful, if the MAFWE has the capacity and political standing to function as a regulatory and policy implementation agency - a role assigned to it by the NWL.

3.3 The precarious situation of irrigation agriculture: temporary or permanent, external or internal incentive problems?

Macedonia has about 665.000 hectares of arable agricultural land. Of these about 400.000 have a potential for irrigation, 123.100 have been developed for irrigation in the past, but only 36.146 have been irrigated in 1999 [14] . The main reason for this extreme case of under-use of a valuable resource can be explained by the above mentioned vicious cycle in which WMO and irrigation farmers are caught. The ‘mounting accounts receivable of questionable value’ mentioned in a recent financial review of four WMO certainly refer mostly to unpaid irrigation service fees [15] . The recovery rates of 88% reported for 1990 have come down to 35% in 1995. It is quite obvious, that the dissociation between water fees, marginal costs (high for unreliable water delivery in terms of timing and quantity and productivity enhancing inputs) and marginal value product (low because of low prices and low yields because of unreliable supply of water and other inputs) made it uneconomical for farmers to put their land to productive use and – what is more significant – to stick to established patterns of behaviour.

The contraction in terms of irrigation area is in line with a general trend in the agricultural sector, where increasing costs for inputs and decreasing prices for the output led to a squeeze in productivity, margins, and incomes and, as a consequence, to a general contraction of the sector. In terms of population dependent on agriculture the importance of the sector has been decreasing, from 72% after World War II to 12% in the 1990s. In terms of the trade balance the receipts of exports covered imports by about two thirds on average but there were extreme variations from 7 to 17% between 1990 and 1995, mainly due to the unstable political and economic situation. Of the total cultivated land, 70% belongs to private farms (about 177.000 with an average size of 2.6 ha according to a World Bank study of 1997), about half of the farming population having less than one hectare per family. This means agriculture being a part time activity for most of the families, with parts of family income earned in other occupations inside (as agricultural labourers) and outside the agricultural sector. The ‘agrikombinats’ [16] , cultivating about 20% of arable and about 37% of irrigated land are still considered a dynamic factor, an important employer and a powerful stakeholder in rural areas as well as a particularly relevant but little known force in the efforts to restructure WMOs and organise water user participation and empowerment.

The small size of private holdings, the small and dispersed plots and the large number of part-time absentee farmers might explain the low level of organisation, i.e. missing or weak farmer or water user organisations. They must be seen as a principal structural impediment for solving the acute problems of irrigation agriculture to be based on more user responsibility and control of WMO from below. In the case of four WMO studied in 1996 two thirds of the 26,456 private water users were part-time farmers, some living in cities, only keeping land as a tradition or for security reasons in case of critical economic circumstances. With some ethnic heterogeneity added to this, it may be easily understood that the standard solution of passing responsibility for operation and maintenance to water user associations prescribed by donors and based on theoretical reasoning and experience in other parts of the world [17] in this case seems to be extremely difficult to realise. Client and service orientation of water related services, transparency of water pricing and accountability of WMO to user organisations seems to be a theoretical model far removed from the reality of Macedonia and also removed from informal institutions in terms of customs, of mental constructs and individual policy models, and of system specific rules of conduct between water users.

Given this situation, the fact that policy makers opted for a hierarchical, top down solution to organisation in the NWL might appear in a different light. Up to now, however, this particular approach to a more effective and efficient supply of services to water users has been rough going. There has been little outside support to most WMO and to the PWEE in terms of training in modern management methods and provision of software tools and information technology. So, perhaps, it is still too early to allow a judgement on this approach. Though, as has been pointed out, even these inputs cannot be a substitute for a sound institutional incentive structure giving water users more control over service provision and financing. It remains to be seen if the standard model of irrigation management transfer, to which the efforts of the World Bank financed Irrigation Restructuring and Rehabilitation Project (IRRP) [18] are attuned to in four pilot schemes, will achieve some positive results. The approach largely corresponds to the rules for efficient provision and financing of irrigation projects which will be presented in the third section of the theoretical part of this paper.

3.4 Financing water related goods and services: royalties or levies, service fees or taxes, subsidies or cross-subsidisation?

The NWL unfortunately uses the term water fee indiscriminately for all kinds of payments, from royalties or levies for the use of a natural resource, to service fees, to taxes and other charges. According to article 132 eight different water payments are to be collected, some of them related, some not related to demand and to services provided by the water economy sector. This lack of specificity and consistency of financing instruments will not only confuse communication between stakeholders on the provisions of the law, it also goes against established rules of public finance and makes it impossible to assess who is paying how much and for what reason or purpose. The principle of fiscal equivalence of public finance, meaning that the gains someone draws from public services should – more or less – correspond to the payments in form of fees (in case of services received) or taxes (in case of benefits from public goods) is not respected. Taking as an example the Public Water Fund (PWF) to be created according to article 122 of the NWL, an individual person may pay in three ways to this fund, in terms of a deduction from his or her wage (0.2% water tax), in terms of the payment of a service charge for drinking water and through the payment of general taxes which also will contribute to financing the PWF (see Sander, 1997). The possible incentives or disincentives resulting from this conglomerate of payments are hardly to be assessed.

The lack of fiscal consistency and transparency following from the provisions of the NWL has additional drawbacks. It does not promote trust and willingness to pay, neither of water users nor of other contributors to the PWF. It will not allow to set the right incentives for an effective and efficient collection and use of funds, it might induce moral hazard and rent-seeking behaviour and – last not least – it goes against the principles of equity and justice. Macedonia, of course, is not the only country haunted with this problem. The tradition of funding lumpy infrastructure from general tax money and letting public enterprises take care of it’s operation and maintenance without users paying at least variable costs, is wide spread, not only in transition countries but also in western market economies. Cross-subsidisation within public utility companies and subsidies for transport and other services is still common practice, though recently more and more of these services are being privatised. This process, of course, means a loss of rents to users of subsidised services and to board members and employees in the corresponding sectors. If properly regulated, however, an increase in efficiency and effectiveness will be certain once the disjunction between payers, providers, and receivers of services will be curtailed – one of the sources of non-market failure.

4 An institutional approach to water pricing - some theoretical concepts

4.1 Institutional imperfections and failures

Just as service fees should be distinguished from royalties or taxes, a water fee should generally be distinguished from a water price, even though the terms ‘water price’ and ‘water fee’ are often used as synonyms. This, however, is not quite correct, as pricing usually relates to markets [19] . Here we use the term water price to explicitly refer to markets as well as to other non-market institutional configurations or governance modes for providing and financing water and water related goods and services. The search for appropriate institutional configurations setting the incentives for socially beneficial individual behaviour should be seen as an iterative (trial and error), path dependent process in which imperfections and failures of institutions, transaction costs and strategic behaviour of stakeholders are at the same time subject of the analysis and part of the process. A constant monitoring of this process of guided institutional transformation by an appropriate research institute [20] and by the regulatory authority within the water economy sector (MAFWE) is certainly necessary. Though still not in sight it is certainly a problem to be considered under the topic ‘institution sequencing and timing’ [21] .

4.1.1 Market failures and the narrow perspective of neo-classical economics concentrating on price incentives

Economists consider competitive markets as the most efficient form of co-ordinating individual decisions concerning the production, consumption and exchange of goods and services in an economy. As markets link the costs of producing a good (supply) to the income sustaining it (demand) - given a particular resource base – markets and prices are considered to provide the right incentives for individual decision making, for clearing markets by bringing supply and demand into a socially optimal (fictitious) equilibrium, this by eliminating inefficient suppliers. In addition, market prices provide a straightforward way to estimate the (scarcity) value of a good or service.

Efficiency is a central term used by economists as yardstick to assess activities as well as outcomes and institutions. The term generally refers to the cost-minimising or profit-maximising provision of a good or service, allocation of a resources, or functioning of an institutional arrangement. The exchange of goods and services and the allocation of resources within a market economy are considered efficient in a (fictitious) equilibrium situation in which nobody can be made better off without anybody else being made worse off [22] . Competitive markets, by eliminating inefficient providers are considered the driving force leading to efficient outcomes [23] , the prices in these markets giving the right incentives to economic agents – to producers and consumers as well as to traders and service providers. ‘Right’ in this case means prices reflecting the real costs or benefits of the goods and services to society. In case of the deviations of actual (financial) prices from socially optimal ones, economists talk of ‘ market failure’ requiring direct regulation and policy interventions. Also, adjustments of prices will be necessary when using them in the economic assessment of policies and projects [24] .

Within the water economy sector, a range of marked failures are possible and we will distinguish four types, though only the first two are generally considered as such in mainstream economics. The first, the public good type market failure refers to a situation, where a good or service will not be provided in a socially optimal way by private initiative through markets; either not at all, or not efficiently or not sufficiently. The reasons might be (i) a market does not come about because of the particular intrinsic properties of a good, e.g. the exclusion of non-paying users is not possible (free rider problem), (ii) markets do not provide enough [25] of the good or service because not all the positive effects are compensated for by the market price, private providers thus making a loss ( positive externalities); (iii) the provision of a good or service requires an investment which is very risky , which is subject to increasing returns to scale (decreasing average costs), which is very specific for a particular purpose, very costly or has a long gestation period (infrastructure and lumpy investments ). Once the investment has been done in these cases, it is very difficult for a competitor to offer corresponding goods or services. This ‘ natural monopoly’ case applies to many lumpy infrastructure investments in the water economy sector [26] . It should be noted, however, that a public good type of market failure does not necessarily mean, that the good has to be ‘publicly’ provided, particularly not by the central government. It might be just as well be provided by local governments, by an organisation of civil society or by collective action.

The second type of market failure refers to the well known case of external costs ( negative externalities), i.e. costs not reflected in the market price. This under-pricing or non-pricing of a good or resource (or a particular feature of it) leads to a consumption or use pattern not corresponding to a social optimum. Environmental degradation or pollution and the exploitation of a natural resource beyond a sustainable level are cases in point (in the water sector e.g. deterioration of water quality, soil degradation because of salinity and water logging, overuse of fossil groundwater). Also in this case rules concerning the use, the management and the fees for it’s use might not need to be provided by the central government. Local governments, civil society organisations and collective action at some other level might provide more adequate solutions. The final distribution of water delivered in bulk to a water user group, the management of a local watershed, of a forest or communal pasture are examples.

The third and fourth types of market failure usually are not subject of concern in neo-classical economics which is generally concerned with allocation and economic efficiency issues. Questions of equity and distribution of property rights are taken care of by assumptions [27] . Neo-classical welfare economics, the conceptual base for a SCBA assumes the distribution of property rights to be optimal and a policy or project as socially efficient (‘pareto optimal’) if winners, even after compensating losers, are still better off with the project and policy then without it. As this compensation is only assumed but rarely done in the case of real live natural resource or water projects, compensation will need to be considered right from the beginning and enforced by some higher authority if the more ambitious goal of social efficiency is to be attained. Poverty and equity problems as cases of market failure will require special institutional provisions to take care of them.

The fourth type of market failure , the problems of imperfect or asymmetric information and the costs of transacting in markets and non-market institutions are not considered in neo-classical economics. Institutional economists have focused on these problems, referring to agency problems of non-market institutions or organisations.

4.1.2 Non-market failures and non-price incentives - the extended institutional perspective

The term non-market failures is less used, even though the corresponding phenomena are well known - from developing and developed as well as from centrally planned and market economies. Besides the agency problems the term refers to problems arising in political bodies, state bureaucracies, public and semi-public enterprises as well as in non-governmental organisations such as non-profit research and development organisations, foundations, charities, political and grass-roots organisations where the funds to sustain their activities usually are not earned in the market. In this case, there is no built-in mechanism (market competition) to eliminate organisations which cannot cope properly with the second type of non-market failures as well as with other sources of inefficiency, ineffectiveness, and redundancies. Non-price incentives and disjunction between costs and revenues in the public and non-profit sector

In the case of a water economy sector, politicians and decision-makers in public and semi-public entities involved in regulating the provision and financing of water and water related goods and services deal with a natural resource belonging to the state (water) and with financial resources, provided mainly by tax-payers and by international finance institutions, generally from loans under very soft conditions. Handling these resources means power, influence, reputation. Besides the incomes earned, there might be rents involved, sometimes even payments beyond the line of legality. Any changes taking place in the existing system of regulating access to water, to tax money or aid will mean an impact on these items or, at least an impact on stakeholder perceptions of the changes in these items concerning their particular stakes, i.e. their expected gains and losses. Thus, in the case of the introduction of a new water fee system there might be stakeholders who try to block or promote specific instruments for funding irrigation infrastructure or water pricing (see e.g., Repetto, 1988).

Lobbying, rent-seeking, or corruption are some phenomena relating to this first type of non-market failure due to self serving behavioural patterns of politicians and bureaucrats. Features of neo-classical theory have been applied to the analysis of these non-market failures in government bureaucracies and political institutions by political scientists of the Public Choice and New Political Economy (NPE) schools of thought. The subject of analysis is the individual motivational structure in the political realm, with methodological individualism, individual preferences and utility maximising of political actors being elements corresponding to neo-classical economic theory [28] . Voices have been raised, however, against oversimplified policy conclusions from these theories. Their ‘profoundly cynical view of the state in developing countries’ (TOYE) has been criticised as well as the corresponding bias of neo-liberal policies towards market-orientation, state-minimalism and privatisation of natural resources promoted by international development finance institutions (‘Washington Consensus’) [29] .

On the other hand, the disjunction between costs and revenues in non-market organisations, i.e. organisations which do not sustain themselves by selling goods and services in the market, has been pointed out by WOLF (1988) as the main source of non-market failure in government agencies. “The predominant and ineluctable source of non-market failure lies precisely in those circumstances that provide the rationale for non-market activity in the first place” (Wolf, 1988: 63). He sees the lack of a mechanism to eliminate inefficient and ineffective providers comparable to the competition and price mechanism in the market as a source of redundant and rising costs inherent in public as well as other non-market organisations and describes internalities and organisational goals as well as derived externalities, as other sources of non-market failures, with power and privilege leading to distributional inequities [30] .

Considering the similar source of non-market failure in non-governmental, non-profit or charity organisations (NGO), it does not surprise that the run of international development finance institutions to working with NGOs as intermediaries between the state and local organisations and as providers of goods and services to beneficiaries of aid seems to be over. Donors as well as NGOs themselves are increasingly aware of the inherent sources of non-market failure in NGOs. They try to cope with problems of non-market failure, e.g. by introducing mechanisms of tendering for service contracts. As mentioned earlier, this way competition for markets releases the beneficial forces turning private vices into public virtues, as Adam SMITH described some 225 years ago the positive function (‘invisible hand’) of markets. But even linked to the market, there are still the other sources of non-market failures, the agency problems mentioned earlier. COASE and WILLIAMSON have pointed to these problems and to the solution: attaining an appropriate mixture of the market and the non-market for a specific sector or industry avoiding their specific failures and minimising transaction costs. Asymmetric distribution of information and transaction costs – non-market failures within public, non-governmental as well as private organisations

Since COASE and WILLIAMSON have first pointed out the importance of transaction cost and agency-problems related to asymmetries in the distribution of information and the corresponding problems of shirking, moral hazard, and adverse selection the topics and sectors studied have become innumerable. Based on neo-classical economic theory new institutional economists are looking at incentive and selection problems in a wide range of market–non-market institutional configurations and thus bridge the gap between the market and the non-market. Though still not coming up with much quantitative material on transaction costs or straightforward rules for the design of institutional set-ups in the market non-market range, they point – among others - to the importance of principal-agent relationships, to strategic behaviour of economic agents, to non-price incentives, to the relative costs of creating and transacting in institutions, and to the general importance of information, of transparency, and of accountability [31] . The concepts cannot be discussed here in more detail, but they are certainly relevant in the reforms of the Macedonian water economy sector and the introduction of a new water fee system. Taking the subject of principal-agent relationships there are several to be considered when looking at natural resources management in Macedonia, particularly the relationship

· between the electorate and the Government,

· between the Government, represented by the Ministry of Agriculture, Forestry and Water Economy (MAFWE), and the PWEE,

· between the PWEE and the WMO [32] , and

· between the WMO and the water users.

In the last case, however, the perspective should be turned around, seeing the farmers and water user organisations as the principal and the WMOs as the agents, with an incentive system to be designed in a way as to making WMOs respond more to the needs of the clients – to the farmers in the case of the agricultural sector, to other users in the energy and industrial sectors and, last not least, to the consumers for which high quality drinking water is the central basic need. Rivers and lakes, on the other hand, give an impressive scenery, a habitat for bio-diversity and a source of recreation activities. An important step towards such a client-oriented approach will be the identification of the different types of goods and services involved in the water economy sector and the corresponding specific demand conditions.

4.2 Intrinsic properties of goods and resources and the demand conditions of water and water related goods and services

In the case of water and water related goods and services we are faced with a variety of goods, each one with it’s particular properties and significance for potential users. We will therefore first have a general look at how intrinsic properties of goods and resources determine the way a natural resource is managed or provided - by a public agency, by the market, or by some communal or collective effort. In a second step we will see how water and water related goods and services can be analysed from the point of view of it’s provision, use and demand conditions.

4.2.1 Private, public and mixed goods

In the literature, several approaches for categorising goods from an institutional perspective are known. A first approach distinguishes two intrinsic properties of goods [33] , namely excludability and rivalry in use (sometimes called substractibility) allowing the identification of four principal types of goods in a 2 x 2 matrix: private goods, public or meritory goods and mixed goods, the latter subdivided into the categories of club and collective (or common pool) goods. The intrinsic properties hint to the type of institution needed for provision or management, rivalry meaning in this case two users cannot use the good or resource without affecting each other’s utility. Excludability refers to the exclusion of free riders i.e. any users not willing to pay the market price or a user fee.

In terms of institutional configuration for management or provision there is, firstly, the most common case of well specified private goods to be provided by the market. The properties of excludability (by technical and/or institutional means i.e. the market price) and rivalry in use (i.e. the good cannot be consumed twice or by two users) are both given. There is, secondly, the well known group of pure public goods. They are non-rival in use and exclusion of free riders is technically not possible or socially and economically not feasible. For some pure public goods, often called meritory goods, provision by a public sector institution or a government agency is generally considered necessary. As an example, introducing formal institutions, like formal property rights to water, formal (market) regulations for trading water rights and irrigation land are meritory goods.

Many goods and services formerly provided by public entities might be reassessed from time to time as either the intrinsic property of non-rival use or the technical, economical or social feasibility of exclusion might have changed over time. Thus, in the case of the management of natural resources and the provision of water and water related goods and services, former meritory goods nowadays are rather considered mixed goods, as scope for technical or institutional interventions to exclude non-payers and for organising the management and provision by collective action or by private bidding for service contracts is seen. The arrangements might be different for club or toll goods and for common pool goods or resources . The first still have the properties of non-rival use, but the possibility for excluding free riders is given, either by institutional or by technical measures or both. In the case of the second type of mixed goods, the common pool goods or resources (CPR), rival use is given. Collective action of users, however, is possible e.g. for designing management rules to cope with problems of rivalry in use of some range or forest land, or, in the case of irrigation, for providing a small (‘non-lumpy’) infrastructure, for operating and maintaining a water distribution system and for financing these activities.

As a consequence, in all situations where the indicated properties of mixed goods are given or likely to be given, the public good market failure argument as a reason for public intervention or provision needs to be carefully assessed. In many cases a closer look at the specific situation will allow to discriminate between different goods involved or perhaps different properties of one specific good or resource, each with a different potential institutional configuration. Examples have been described where services or tasks formerly seen as non-separable (like e.g. up-stream large infrastructure and down-stream distribution systems in irrigation) have actually been identified as separable, partly to be managed by collective action, partly to be provided by the public or private sector. With each institutional configuration the specific efficiency and effectiveness enhancing properties of institutions can be aligned with the corresponding specific intrinsic properties of goods, services or resources [34] .

Girishankar & De Silva (1998) looking at goods and services from the perspective of strategic management in the public sector distinguish the two intrinsic properties of specificity and contestability of goods and services usually supplied by the public sector. They propose markets and mixed-good type modes of governance in which the state only intervenes with some regulatory measures. High specificity (i.e. possibility for specifying an output with precision) and high contestability (absence of barriers to entry of alternative providers) are the corresponding properties allowing non-public provision. In the case of the operation and maintenance of a major infrastructure, for instance, competitive tendering every so many years allows the supply of a well specified service while, at the same time, limiting redundancies and rising costs over time [35] . For other tasks, like the creation and protection of formalised property rights to water and irrigated land, for the design and monitoring of policies non-market supply by public bodies will be necessary. Thus, a sector-wide system of charges for the use of a natural resource owned by the state and for a public service provided, certainly is a meritory good and a public body within the water economy sector the appropriate entity to initiate and supervise the elaboration, implementation and application of such a system.

4.2.2 Supply and demand aspects of water and water related goods and services

Even though, a market for water has not been considered in Macedonia, markets for water related goods and services are an issue. Supply and demand related issues occur even without having a formal market. Thus, consideration of location and time specific scarcities, of average and marginal costs (supply) and of willingness and ability to pay (demand) is important. They will need to be assessed, qualitatively or quantitatively, in order to find institutional set-ups which come as close as possible to a (fictitious) equilibrium situation corresponding to the social optimum referred to in welfare economics. Efficiency as well as equity and sustainability considerations need to be included in this assessment, concentrating on the following range of goods with their particular properties:

· water as a renewable natural resource , available cost free to society and humanity, originally abundant and of good quality, but subject to site and time specific scarcities and quality differences, due either to natural or to human factors or interference (often public good and externality type market failures),

· water related infrastructure, e.g. source structures, infrastructure for pumping, diversion, adduction, storage, distribution (often, but not necessarily, public good type market failures in case of ‘lumpy investments’, free riders, positive externalities, or natural monopoly),

· water related services, e.g. providing and cleaning water, disposing of waste water, operating and maintaining infrastructure (mostly market provision possible, market surrogates or collective action),

· water related regulatory tasks for securing the public interest, the interests of future generations or of humanity, e.g. regulating the water regime, restricting, granting and enforcing property and user rights, resolving conflicts, within a country or internationally (public good type market failures, meritory goods).

Thus, a comparative analysis of policy instruments such as taxes, charges and service fees and of technical and institutional exclusion measures will need to be oriented by the type of good and it’s specific properties. On the supply side, the cost structure of the different activities for the protection, development and use of water and for providing, operating and maintaining corresponding infrastructure will be the point of departure. These costs need to be covered, respectively financed and recovered by appropriate financing mechanisms. Marginal costs for providing additional quantities will indicate the scope for efficiency-pricing and for supply side policies, though, in case of natural monopolies, not a straightforward affair. Subsidies for fixed costs might need to be considered in many cases. On the demand side, the various prevailing demand conditions of water and water related goods will allow to assess ability and willingness to pay for different uses, users and sectors, and the related incentive and disincentive effects of particular policy instruments , including the scope for demand oriented policies. In a first assessment, the following types of demand conditions can be distinguished:

· a direct demand from consumers for the purpose of recreation, tourism, and drinking; the latter a basic need and thus to be distinguished from the former,

· a derived demand from producers as a central input in irrigated crop production and as an input in industrial production [36] ,

· a derived demand from industry for cooling purposes and as a sink for wastes in different industries, and, finally,

· a derived demand from the energy sector for the generation of electric energy and as a means of transport.

The prevailing demand conditions will be a determinant of the methodology for assessing the value of resources, goods and services (market or non-market valuation) as well as for the estimation of socially acceptable and justified service fees or charges (willingness to pay derived from market demand or directly assessed ability to pay), and for the generation of financial means to cover costs.

As a consequence, both supply side and demand side aspects will have to be considered in the design of the new water fee system in Macedonia. Specific regulatory provisions to avoid distortions in the price and non-price incentive structure, mis-allocations of resources and socially unacceptable outcomes are needed and translated into incentive mechanisms to promote efficiency and effectiveness enhancing innovations by the WMOs respectively the branches of the PWEE .

4.3 Institutions for providing, financing, operating and maintaining irrigation infrastructure

As has been pointed out before, the provision and financing of water related goods and services are two separate but closely related issues. The previous analysis suggests that in many cases the provision and the sources of financing might not be directly connected, i.e. the receiver of a good or service might not be the payer. The multiplicity of types of goods and the different demand conditions prevailing as well as the different forms of provision (market, non-market and mixed) makes the question of financing a particularly complex one. In the case of a private good with market provision, the provider will cover his or her costs and profits from the prices charged to the buyer of a good or service. Here, the problems of disjunction non-market failure indicated above will not occur. In other cases, however, e.g. in the case of a pure public or meritory good, financing from other sources like levies, royalties or taxes, perhaps combined with some service component, a mixed financing arrangement might be found. General criteria for the financing arrangements are economic efficiency, effectiveness, accountability to a public entity and to users, equity or social justice and, last not least, the necessity of covering costs, the latter certainly a precondition for sustainability of any institutional configuration. Some of these criteria a more difficult to assess in a normative analysis than others. The following example of an assessment under the limited neo-classical efficiency perspective comes up with rules as to the design of an institutional configuration for the provision and financing of irrigation projects.

4.3.1 Rules for providing and financing irrigation projects

Looking from a social market economy (ordo-liberal) and economic efficiency perspective, Hatzius & Margraf (1994) derive normative rules for institutional choice and apply them to irrigation projects in Peru. These rules are considered a precondition for sustainable project outcomes. Reference is made to two basic principles. Firstly, the subsidiarity principle originating in catholic social theory. This principle states that a higher organisational unit should only take over a specific task if this task asks “too much” of the subordinate unit. The second principle is known from the theory of public finance and is called principle of fiscal equivalence. Two rules are derived analytically, the first one coming in two versions, 1a and 1b, the former for the case of a predetermined size of the group of beneficiaries, the latter in the case the size of the group is not predetermined. As the question of size of irrigation systems has an influence on the complexity of it’s operation and maintenance, on the willingness of water users to participate in O&M activities (organisation & maintenance), and on the ability and willingness to pay, version 1b of the rule is a particularly relevant one. The two versions of the first rule are as follows:

· The users of a good should pay for the provision of the good and only the users (= payers) should be given the right to decide on the provision of the good. (1a),

· The range of people using the good provided by the project has to be restricted taking into account that the exclusion technique to be applied is, from an economic point of view, useful (1b). In addition, apply rule 1a.

The usefulness of an exclusion technique needs to be evaluated in terms of it’s economic costs and gains, the latter consisting of the avoided cost of overstocking, overcrowding and/or the avoided rationalising fees which would incur or would have to be charged if the range of users were not restricted [37] . The second rule, the ‘realised financing rule’ - again only under economic efficiency considerations - states:

· Every user has to make a payment equalling the economic marginal user costs. If these payments are not sufficient, additional lump sum charges have to be implemented.

Even though the rules are derived under the very restrictive assumptions of neo-classical welfare economics discussed earlier, they point to some important aspects to be considered when investing in irrigation infrastructure. Assisting irrigation agencies and water user groups with institutional development measures to organise the provision and financing of water related services are certainly important features of such a policy. The ex-post analysis of irrigation projects in Peru shows, that the rules were more or less respected in the case of small projects in the Andean mountains, ignored, however, in the case of a large coastal project.

The insights from this approach for Macedonia might be resumed as follows: (i) Users should be involved in the financing and decision making on investments and O&M services in irrigation, (ii) exclusion, i.e. restricting the number of users and payers, should be considered for economic efficiency considerations whenever it is socially accepted and the economic gains of an exclusion technique exceed the costs, (iii) marginal cost pricing oriented in the ‘economic marginal user costs’ is recommended. This holds true for a private good or service with market provision as well as the collective provision of a good or service. Any further payments, either by the users or from other sources (e.g. water fund) should be made as ex-ante specified lump sum payments for allocation efficiency reasons.

Institutional configurations or governance modes for supplying operation and maintenance services have to take into consideration the state and complexity of the adduction, storage and distribution systems (primary, secondary, tertiary) involved. An interesting approach developed by the GTZ sector project “Maintenance Strategies in Irrigation” gives interesting insights into the differences between a good and a service.

4.3.2 Governance modes for O&M services in irrigation

In their analysis of service provision with case studies from irrigation projects in Peru and Bolivia, Huppert & Urban (1998) point to the particular need of interaction between provider and customer in the case of services as opposed to goods. In a goods-services-continuum they classify various irrigation related services in development co-operation projects as more product or more process oriented. In an instructive graphical analysis a mixed market non-market composite governance mode is presented in which stakeholders involved in the provision of a service are related in an open network. Here, service fees do not necessarily cover all the costs involved in a service but are supplemented by other source, e.g. subsidies based on other charges or taxes.

Though concerned with the operation and maintenance of irrigation infrastructure only, the methodology can be easily extended from a composite public utility governance mode to a whole water economy sector as complex as the one in Macedonia, with lumpy investments like dams and hydro-electric plants being financed, operated and maintained by different agencies within the sector. They might be financed by private or public entities and operated and maintained either by a public utility enterprise or by a specialised private enterprise under a periodically tendered, well specified service contract. The same holds true for the primary distribution system. It might be either run under a service contract by a private enterprise with a periodical new tender arrangement or, if water users are able to create a service organisation, under their own control. Operation and maintenance of the secondary and tertiary distribution systems might be done by collective action with a communal or co-operative type of organisation to be defined.

5 Current issues of institutional reform in the Macedonian water economy sector - some conclusions

The four main issues of institutional reform in the Macedonian water economy sector presented in the first part of this paper have been formulated as questions. Both, the first, applied part of the paper as well as the second, theoretical part have tried to relate the conceptual to the practical issues in the text. Thus, in this last, concluding section these issues will not be taken up again. This section will instead give some preliminary and tentative answers to the four questions asked. The first and the third question, related to the organisational set-up of the water economy and irrigation sectors will be treated together as well as the second and the fourth question, which are related to national water policy. In both sections, special emphasis will be given to questions related to the new water fee system.

5.1 The organisational set-up of PWEE and WMO and the situation of irrigation agriculture

With respect to the first and third questions concerning the public water economy enterprise (PWEE), the regional water management organisations (WMO) and the irrigation sector, the recentralisation of management and control should only be a temporary one and be given up as soon as possible. Both, the PWEE and WMO should consider themselves as service organisations, the former offering services to the government, to the WMO as well as in the market. The latter mainly offering services to water users, in particular to the farmers in the irrigation sector but also to the other sectors, such as communal water supply, energy, industry and tourism. In exceptional cases, income generating activities not related to water and to the tasks specified in the NWLmight be economically justified. Horizontal integration with non-water related activities, however, don’t seem to promise any economies in the medium and long run.

The calculation of fees charged for services should be based on real total cost estimates for the different services. As both PWEE and WMO will perform tasks of public interest, some lump sum subsidies might need to be paid to them from public funds. These transfers should be clearly spelt out ex-ante and should be based on the data presently collected by WMO personnel in relation to the new water fee system. The variety in composition, technical specifications and year of construction as well as in book and actual use value and maintenance costs will require system-specific formulas for the calculation of water fees and their adjustment to changes in prices over time. Operational losses should not be covered by ex-post subsidies. Cross-subsidisation at the local level, as it has been practised in the past, is only to be recommended for a transitionary phase until the financial situation of WMOs has been consolidated. Sector wide cross-subsidisation will be treated in the next section.

The feasibility of water user associations (WUA) in the case of Macedonia is being tested in four pilote areas, supposedly with questionable results. There is certainly a lack of farmer participation in the present organisational set-up of the Macedonian water economy sector. This is reflected in the lack of representation in the governing or supervisory bodies of the WMO, the PWEE and the PWF. Also on the regional level, the agrikombinats still seem to dominate farmer and other organisations as well as the corresponding WMOs. These problems might change with time, once privatisation has been completed and with the improvement of the general economic situation to be expected - in the country as well as in the agricultural sector.

Strengthening of water user and farmer organisation is an extremely important issue, but not an easy one in Macedonia. The objective should be that water user associations will be able to do efficient and effective monitoring of service delivery by the WMO, will be receiving water in bulk and will be taking over water delivery within the secondary and tertiary distribution systems. Also maintenance of these systems should be passed on to farmer controlled organisational set-ups. The data collection effort will give transparency as to the most appropriate point in the system for water users to take over water in bulk as well as management, operation and maintenance.

5.2 The national water policy and the financing of water related goods and services in the water economy sector

For the time being the elaboration of a new water fee system cannot be based on a consistent national water policy. The delays in the elaboration of the water master plan supported by the GTZ-umbrella project is an indicator of the lack of importance given to the issue of a national water policy and of a deficient co-operation of the stakeholders.. Also the commission charged with the elaboration of a new water fee system for the time being is only concentrating on irrigation, as this is the principal sub-sector of the water economy sector at the moment. Other sectors have been informed about the on-going activities, in particular the data collection. Up to now, however, there are no members from sectors other than agriculture, forestry and water economy working in the commission. As the questions of willingness and ability to pay for water fees and possible cross-subsidisation between groups of water users and sectors will be a central one, participation of other sectors is urgently needed, including the provision of data on the income and cost situation in specific sectors and sub-sectors. This participation and provision of data is a conditio sine qua non , at the latest once the present data collection concerning water storage, adduction and distribution infrastructure will be finished and the formulas for the distribution of costs to different sectors to be discussed.

The delays in the data collection effort as well as in the elaboration of the water master plan seem only partly to be a problem of lack of political will and of resources. Seen in the context of the conceptional deficiencies in the NWL concerning the financing of water economy sector activities and the obvious difficulties of the PWEE to take over the tasks assigned to it by the NWL, this is also an indicator for the lack and deficiencies in human capital in terms of technicians and professionals, including economists, and in particular in terms of lack of professional and managerial background and experience as well as lack of training in methodology and in the use of strategic planning tools. The staffing of the PWEE, WMO and of projects in the water economy sector, including the elaboration of the water master plan and of a national water policy, has posed serious problems. Compared to the private sector, public sector jobs are not very attractive at this time of take-off of the Macedonian economy.

Coming back to the topic of this symposium and the contents of this paper, it is doubtful, that the theoretical and methodological issues treated in the present paper will be taken up by those within the water economy sector who eventually have to participate in the elaboration of the final version of the water fee system, i.e. the system specific formulas for water fees, and by those who need to approve it. This is indeed a question of institution sequencing and timing. As with many other development and transition issues, institutions for the formation of human capital are considered the starting point for any successful strategy. As might have become clear from this paper, the formulation of the topic of this symposium which suggests an optimism inherent in the traditional approach to economic policy described in the introduction is not justified in the case of institutional reform of the water economy sector of Macedonia. In this particular case - and perhaps in many other cases - it resembles more a path dependent process of trial and error, requiring much patience, flexibility and innovative capacity of the people involved.


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[1] The paper has been presented to a mini-symposium on “Institution Sequencing and Timing in Transition Economies” at the XXIV. International Conference of Agricultural Economists (IAAE) Berlin in August 2000. The author would like to thank Gertrud Buchenrieder, University of Hohenheim, for her initiative in organising the symposium and shaping the present contribution. He also would like to thank GTZ for allowing the use of some parts of a paper written for the sector project “Maintenance Strategies in Irrigation” and Walter Huppert of GTZ and Douglas L. Vermillion for useful comments on this first paper. The responsibility for the contents and opinion expressed in the present paper, however, is exclusively his own and is beyond the terms or reference of the advisory work for GTZ.

[2] Evaluation methodology in cases of ex-ante evaluation, however, often recommends non-consideration of these costs (‚sunk costs‘)

[3] There are, of course, other factors working towards ever bigger and more expensive infrastructure, related to the rent-seeking phenomena to be discussed later-on in this paper.

[4] In the determination of water user fees, the high initial investment costs lead to decreasing average costs and to the problem that marginal cost pricing, which is generally recommended for economic efficiency reasons, does not cover fixed cost. As marginal cost pricing in this case does not lead to full cost recovery, full cost recovery and subsidisation are critical issues in institutional design in the water economy sector and, more general, in natural monopolies, see Coase (1988).

[5] See e.g. North (1992), Witt (1993), Brandes (1995), Eggertsson (1997).

[6] The number is sometimes given as 26, probably due to some sub-units being considered as separate WMOs.

[7] The principal tasks of the public water economy enterprise (PWEE) are „Construction, maintenance and utilisation of water management facilities dealing with provision of water for water supply, irrigation and drainage; protection zones; control of the harmful effect of water; protection of the riverbeds and riverbanks; flood control, erosion and torrent control; sand, gravel and rock dragging for the purpose of protecting and improving the water regime; provision of water reserves that will secure a unique water regime in a catchment area or a section of a catchment area and elaboration of project documentation and studies for improving the water regime“ PWEE (1999)

[8] Debt-enforcement for outstanding water fees or loan repayment in Macedonia seems to be almost inoperative. WMOs have more than 40,000 cases awaiting decisions by the courts (Lee, 2000).

[9] See e.g. Fukuyama (1995).

[10] According to another source (JICA,1998) total water requirement – including a biological minimum requirement of 10% of average flow - in 1996 has been 2,416 (2,235) mill. m³/year, with a distribution of 9.02 (16,2) percent for municipal water, 56,04 (42,5) percent for agriculture, 4,72 (12,08) percent for industry and 30,22 (29,22) as biological minimum (alternative scenario in brackets).

[11] A significant decline in the water level of the Prespa and Doyran Lakes has been reported for the last 15 years, see ICID (1999). Shortages of drinking water have been reported for most municipalities of the country and problems of pollution of rivers and lakes by untreated industrial and domestic waste water have been identified for various locations, see JICA (1999) ‘Study on water resources development and management master plan in the former Yugoslav Republic of Macedonia’, Final Report Vol. I, Figure 6: Location Map showing Development needs and Environmental issues.

[12] There are considerable differences with respect to quality and quantity, time and space in the 10 different river or lake systems distinguished in JICA (1998), with a total catchment area of 25,713 km²

[13] ‘Beratung des Republikamtes für Wasserwirtschaft, Makedonien’ PN 95.0786.4, The ‘umbrella’ project supports, among other activities, institutional development in the Water Sector by providing short term consultants.

[14] Unofficial information from the Ministry of Agriculture, Forestry and Water Economy (MAFWE).

[15] In the first half of 1999 only 20% of the total income of the 24 branches came from paid irrigation service fees.

[16] Large, vertically integrated publicly owned enterprises. At the time of independence they cultivated about 200,000 hectares of state owned land, the 50 largest85% of this land.Just like the WMO, they have serious management and incentive problems and are left to struggle having lost privileges, like access to cheap ‘credit’. A study of the political economy of privatisation efforts of agrikombinats would probably reveal some interesting insights.

[17] See e.g. the International Irrigation Management Institute (IIMI) Short Report Series on Locally Managed Irrigation.

[18] A recent appraisal mission of the project might have come up with some new ideas how to cope with the problems. The corresponding report, however, has not been released yet.

[19] Though a price might also be set in an auction or by a firm launching a product in a market, with adjustments then taking place according to the demand side.

[20] The Water Development Institute (WDI) seems to be the best developed and largely independently managed one for the time being with (in 1998) a staff of 24, of which, however, 14 are engineers and only one an economist.

[21] A thorough analysis of roles and capacities of public, semi-public and private organisations within the water sector has not been done up to now and cannot be done in this paper. It is, however, urgently needed in view of the design and implementation of the new water fee system.

[22] This so-called PARETO-efficiency has been named after the economist who formalised the corresponding analysis of an economy. The concept has also been applied to the internal organisation of a Public Sector Agency, where the (i) identification of a core strategy, (ii) institutional arrangements between principals and agents, and (iii) process design and the organisation of work have been identified as the three layers of an efficient public sector agency, see Girishankar & De Silva (1998)

[23] The supposed elimination of inefficient institutions, however, only applies under a range of assumptions inherent in the neo-classical model.

[24] Social Cost Benefit Analysis (SCBA) use shadow (economic or social) prices instead of actual (financial) market prices, either adjusted to account for market failures or derived from international prices.

[25] In terms of a social optimum.

[26] The implications for pricing in this case are not clear and have led to the so-called ‚marginal cost controversy‘, see e.g. Coase (1988, reprint from 1946).

[27] Perhaps instead of market failure we should therefore be talking about model failure – the failure of the neo-classical model of an economy to capture important features policy makers are faced with in reality.

[28] In particular game theory is used to investigate strategic behaviour of optimising individuals.

[29] See e.g. Toye (1991) and (1993), Streeten et al. (1995), Baland & Platteau (1996).

[30] See Wolf (1988), particularlyChapter 4.

[31] See, e.g. Richter & Furubotn (1996), Erlei et al. (1999).

[32] As long as there is no new management structure within the PWEE nor a clear distribution of responsibilities between managers on the central and local levels WMO managers do not take decisions unpopular with either their own local constituency or with the central office: no disciplinary measures nor reduction of personnel, no water cutting to non-paying water users, no incentives in forms of discounts for old debts to improve debt payment – all measures being discussed but never implemented.

[33] The term good comprises also resources, services and institutions

[34] See Weltbank (1994), Blankart (1994), Keohane & Ostrom (1995), Hatzius (1999).

[35] Here, competition does not take place in the market but for a market!

[36] The value of water might be derived from the willingness to pay for the final output of agricultural and industrial goods, see e.g. Hatzius & Margraf (1994) for the valuation of irrigation water as a collectively used input to agricultural production.

[37] In terms of market failure, exclusion, if socially accepted, thus contributes to economic efficiency by minimising transaction costs and internalising externalities.