WATER RESOURCES MANAGEMENT

CE 8415

MBEYA UNIVERSITY OF SCIENCE AND

TECHNOLOGY
Coordinator: Ms. Margaret S. Kironde
Economic analysis
• Economic analysis refers to evaluating costs and benefits to check the
viability of a project, investment opportunity, event, or any other matter. In
other words, it involves identifying, evaluating, and comparing costs and
benefits.
• The analysis process contributes to the optimal allocation and use of
resources, forming an important element in the decision-making process.
• Economic analysis of projects helps identify and select public investments
that will sustainably improve the welfare of beneficiaries and a country as
a whole.
• It can help in estimating the project’s fiscal impact and inform
government/implementing agency accordingly; it can also determine
whether there is scope for cost recovery and that arrangements are
efficient and equitable. In addition, it can help in assessing the project’s
potential environmental impact and contribution to poverty reduction.

• Costs include both the initial investment and the annual maintenance and
repairs.
• Benefits include all of the annual returns upon which society places value.
The life of the project will also be an important consideration. A problem
arises when not all of the costs or benefits can be quantified or valued.
Example
• Paul has a small factory producing specific bottled products; currently,
he has twenty workers, and the daily output is 3000 bottled products
for delivery. Paul plans to employ heavy equipment and machinery and
automate the whole process. However, if he does, it will cost him a fixed
amount due to machinery purchase and automation system installation
costs.
• However, the new step increases the production output and reduces the
variable labor cost. Evaluating the cost and benefit associated with
automated and manual processes implies that the automated process is
better. It is a simple economic analysis example through which Paul will
assess and go forward with their decision to install new equipment in his
factory.
• Rudy runs a construction company; he has plans to make a business complex
on the land he bought years ago. But before initiating the project, he applied
economic analysis to understand the vicinity and the cost-benefit scenario
related to the project.
• The analysis helps Rudy finds out that the land is near a lake. So the land
composition is not solid, and the soil around is mostly wet; this is not only a
problematic situation for construction, but it may bring many issues post-
construction, and there can be a potential threat to the building.
• Also, it may harm the lives and assets of people buying shops. At the same
time, people around the land may protest against the construction, and they
will have to face many legal issues. So, in the long run, it can be a bad
investment. Hence, Rudy finally decides to let go of the project and looks for
different alternatives.
Economic analysis entails three main elements:
1. Identification and estimation of costs related to an
investment
2. Identification and estimation of benefits to be obtained
from an investment
3. Comparing the costs with benefits to determine the
appropriateness of the investment.
Water resources
• Since water is a scare resource and an economic good, it is,
therefore, essential to carry out an economic analysis of
projects so that planners, policy makers, water enterprises
and consumers are aware of the actual economic cost of
scarce water resources, and the appropriate levels of tariff
and cost recovery needed to financially sustain it.
• Economic analysis, or the understanding and prediction of decision
making under conditions of resource scarcity, plays a major role in the
planning, design and management of sustainable water resource
systems.
• Economic analysis generally aims to improve the social well being of
society in terms of income or consumption by encouraging the efficient
use of resources.
• Financial viability and project risks are also assessed to test the
sustainability of service delivery and economic benefits. These analyses
are carried out in conjuction with social, technical, institutional and
environmental analyses prior to project appraisal and when necessary
through out the project cycle.
• Economic analysis comes into play at the different stages of the project
cycle: project identification, project preparation and project appraisal.
 Characteristics of Water Supply
Projects
• Water is usually a location-specific resource and mostly a nontradable
output.
• Markets for water may be subject to imperfection.
• Investments are occurring in medium term (typically 10 years) phases and
have a long investment life (20 to 30 years).
• Pricing of water has rarely been efficient. Tariffs are often set below the
average economic cost, which jeopardizes a sustainable delivery of water
services.
• Water is vital for human life and, therefore, a precious commodity. WSPs
generate significant benefits, yet water is still wasted on a large scale.
• The above characteristics have implications on the design of WSPs and
should be considered as early as the planning and appraisal stages of
project preparation.
 Economic Rationale and Role of Economic
Analysis
• The provision of basic water supply services to poorer population groups
generates positive external benefits, such as improved health conditions of
the targeted project beneficiaries; but these are not internalized in the
financial cost calculation.
• Economic analysis should be considered as a major tool in designing
water supply operations.
• Demand for water depends on the price charged, a function of the cost of
water supply which, in turn, depends on demand. This interdependence
requires careful analysis in all water supply operations.
• Safe water should be generally provided at an affordable price and using an
appropriate level of service matching the beneficiaries’ preferences and
their willingness to pay.
• The purpose of the economic analysis of projects is to bring about a better
• In a WSP, the goal may be “improved health and living
conditions, reduction of poverty, increased productivity and
economic growth, etc.”.
• Based on careful problem analysis, the Project (Logical)
Framework establishes such a format showing the linkages
between “Inputs and Outputs”, “Outputs and Purpose”,
“Purpose and Sectoral Goal” and “Sectoral Goal and Macro
Objective”.
Procedures for Economic Analysis

The economic analysis of a WSP (urban or rural) has to follow a sequence of interrelated steps:
1. Defining the project objectives and economic rationale
2. Demand analysis and forecasting effective demand for project outputs. This is to be based
on either secondary information sources or socioeconomic and other surveys in the project
area.
3. Establishing the gap between future demand and supply from existing facilities after
ensuring their optimum use.
4. Identifying project alternatives to meet the above gap in terms of technology, process,
scale and location through a least-cost and/or cost effectiveness analysis using economic
prices for all inputs.
5. Identifying benefits, both quantifiable and non quantifiable, and determining whether
economic benefits exceed economic costs
6. Assessing whether the project’s net benefits will be sustainable throughout the life of the
project through cost-recovery, tariff and subsidy (if any) based on financial (liquidity)
analysis and financial benefit-cost analysis.
7. Testing for risks associated with the project through sensitivity and risk analyses.
Project Preparation and
Economic Analysis
• Before any detailed preparation is done, it is necessary for the design
team to get acquainted with the area where the project is identified.
This is to acquire knowledge about the physical features, present
situation regarding existing facilities and their use constraints (if any)
against their optimal use, the communities and users specially their
socio-economic conditions, etc.
• To get these information, the following surveys must be undertaken in
the area:
1. Reconnaissance survey – to collect basic information of the area and
to have discussions with the beneficiaries and key persons involved in
the design, implementation and management of the project. Relevant
data collection also pertains to information available in earlier studies
and reports.
2. Socio-economic survey – to get detailed information about the household
size, earnings, activities, present expenditure for water supply facilities,
along with health statistics related to water-related diseases, etc.
It is important to analyze the potential project beneficiaries, their
preferences for a specific level of service and their willingness to pay for the
level of service to be provided under the project.
The analysis of beneficiaries should show the number of poor beneficiaries,
i.e., those below the country’s poverty line, and their ability to pay. Such
information is required to ensure that poor households will have access to
the project’s services and to know whether, and to what extent, “cost
recovery” can be done.
3. Contingent Valuation Method - An important contribution in arriving at
the effective demand for water supply facilities, even where there are no
formal water charges, is the contingent valuation survey. This is based on
questions put to households on how much they are willing to pay (WTP) for
the use of different levels of water quantities. These data may help build up
some surrogate demand curve and estimate benefits from a WSP.

4. Survey of existing water supply facilities - Knowledge of the present

water supply sources, treatment (if any) and distribution is also needed. It is
also necessary to know the quantity and quality of water and unaccounted-
for-water (UFW) and any constraints and bottlenecks which are coming in
the way of the optimum use of the existing facility.
• Using the information taken from the survey results and other secondary
data sources, effective demand for water can then be estimated. Two
important considerations are:
Effective demand is a function of the price charged. This is ideally based on
the economic cost of water supply provision to ensure optimal use of the
facility, and neither over-consumption nor under-consumption especially by
the poor should occur.
Reliable water demand projections, though difficult, are key in the analysis
of alternatives for determining the best size and timing of investments.
• Approaches to demand estimation for urban and rural areas
are usually different.
• In the urban areas, the existing users are normally charged for
the water supply; in the rural areas, there may not be any
formal water supply and the rural households often do not
have to pay for water use. An attempt can be made in urban
areas to arrive at some figure of price elasticity and probably
income elasticity of demand.
Identifying the gap between Forecast Need and
Output from the Existing Facility

• it is necessary to arrive at the output (physical, institutional and

organizational) which the project should provide
• Before embarking on a detailed preparation of the project, it is necessary
to take measures to ensure optimal use of the facilities. These measures
should be both physical and policy related.
• The physical measures are like leakage control, replacing faulty valves and
adequate maintenance and operation, etc.; policy measures can be
charging an economically efficient tariff and implementing institutional
reforms, etc.
 Choosing the Least-Cost Alternative
• After arriving at the scope of the WSP based on the gap mentioned
above, the next task is to identify the least-cost alternative of achieving
the required output. Economic costs should be used for examining the
technology, scale, location and timing of alternative project designs. All
the life-cycle costs (market and nonmarket) associated with each
alternative are to be taken into account.
• There can be two main cases for the choice from mutually exclusive
options:
I. The alternatives deliver the same output or benefit, quantity wise and
quality wise;
II. The alternatives produce different outputs or benefits.
 Financial and Economic Analyses
• After choosing the best among alternatives, the next step is to test the
financial and economic viability of the project, which is the chosen, least-
cost alternative. The initial step in testing the financial and economic
viability of a project is to identify and quantify the costs and benefits.
• However, the concept of financial net benefit is not the same as economic
net benefit. While financial net benefit provides a measure of the
commercial (financial) viability of the project on the project-operating
entity, economic net benefit indicates the real worth of a project to the
country.
 Financial vs. Economic Analysis
• Financial and economic analyses are also complementary. For a project to
be economically viable, it must be financially sustainable. If a project is not
financially sustainable, there will be no adequate funds to properly
operate, maintain and replace assets; thus the quality of the water service
will deteriorate, eventually affecting demand and the realization of
financial revenues and economic benefits.
• In financial analysis, the taxes and subsidies included in the price of goods
and services are integral parts of financial prices, but they are treated
differently in economic analysis. Financial and economic analyses also differ
in their treatment of external effects (benefits and costs), e.g. favorable
effects on health and the NRW of a WSP.
• Economic analysis attempts to value such externalities, health effects and
NRW.
Identification, Quantification, Valuation
of Economic Benefits and Costs

• Non-incremental outputs are project outputs that replace existing

water production or supply. For example, a water supply project may
replace existing supply by water vendors or household/community
wells.
• Incremental outputs are project outputs that add to existing supply
to meet new demands. For example, the demand for water is
expected to increase in the case of a real decline in water supply costs
or tariffs.
• Incremental inputs are for project demands that are met by an
overall expansion of the water supply system.
• Non incremental inputs are inputs that are not met by an expansion
of overall supply but from existing supplies, i.e., taking supply away
from existing users. For example, water supply to a new industrial
plant is done by using water away from existing agricultural water.
Distribution Analysis and Impact on
Poverty
• Water supply provision, especially in the rural areas and
shantytowns in urban areas, is considered to be important
for poverty reduction. The poverty-reducing impact of a
project is determined by evaluating the expected distribution
of net economic benefits to different groups such as
consumers and suppliers, including labor and the
government.