Socio economic impacts of droughts and economic instruments

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1 National Capacity Development Training of Trainers (TOTs) Workshop on Developing and Implementing Mitigation and Preparedness Water Scarcity and Drought (WS&D) Management Plans Zaragoza Madrid, Spain, May 6 9, Socio economic impacts of droughts and economic instruments Alberto Garrido Deputy Director, CEIGRAM Professor of Agricultural Economics and Social Sciences Universitdad Politécnica de Madrid, Spain

2 Policy challenge Source: World Economic Forum, 2014

3 Policy challenge Source: World Economic Forum, 2014 Source: World Economic Forum, 2014

4 Policy challenge

5 Content 1. Framework for thinking about drought socioeconomic impacts 2. Economic impacts 3. Economic instruments 4. Virtual water trade 5. The role of insurance

6 1. Framework for thinking about drought socio economic impacts Socio conomic direect costs ( ) Mild drought (1st year) Hydropower Aggregate Direct costs ( ) E Recreation Irrig agric Severe drought (2nd year) Urban sector Forestry Drough Index (SPI) Drought index (Storage) Pre Alert Alert Emergency Rainfed agric 10/1/t 1/1/t+1 1/4/t+1 1/7/t+1 1/10/t+1 1/1/t+2 1/4/t+2 1/7/t+2 1/10/t+2

7 1. Framework for thinking about drought socio economic impacts Categorisation of drought impacts Note: Notation for Domains Residential Sector (RS); Economic sector (ES) and Environment (EV) Direct Indirect Tangible (Market impacts) Urban Water Supply (RS) Agricultural and Livestock Sector (ES) Hydroelectricity (ES) Fishfarm (ES) Recreational Uses (ES) Impacts on the Agroindustrial sector (ES) Agricultural Employment (ES) Tourism and service sector (ES) Type of impacts Intangible (Non market impacts) Welfare impacts (RS) Environmental impacts (EV) Aquatic ecosystems Forest ecosystems Humans health and disease exposure Source Hernández-Mora, N. Marina Gil, Alberto Garrido, Roberto Rodríguez-Casado. (2012). La sequía en la cuenca del Ebro: vulnerabilidad, impactos y medidas de gestión. UPM-CEIGRAM-Madrid. ISBN

8 1. Issues 2. Economic impacts l e t s Se ctor Type of Im pact Methodology Reliability Urban w ater su pp l y Agriculture and li ve s to ck Hydropow er In d u st ry Recreatio nal us es Alleviation and m itigation measures Water su pp l y co m p anies Additional private costs Alleviation and m itigation measures Insurance cl aim s and indemnity los se s Reinsurance im pacts Value of agricultural p roduction Livestock production and health Cost of ex tra energy Aquaculture Cut flo w ers and green ho uses Gathered fro m go vern m en t so u rces Value (M illion ) % of importance High High 0 Estimated Low Gathered fro m go vern m en t so u rces Estimated with data fro m ENESA Estimated fro m data of th e CCS High Reasonable/Indicative Reasonable/Indicative UPM modeling approach High Estimated from various so u rces High 0 UPM approach 0 High UPM with in d u st ry data High 0 High 0 Forest products Government estimates High Navigation Recreational and sp orts fishing Skiing Estimates from sectoral stu d ies and official data Reasonable/Indicative Unknown Reasonable/Indicative 0 Reasonable/Indicative Si gn ific ant but un k no wn TO TAL D IRECT TAN G IBLE COSTS c t l e t s Agro industry Em pl oy m en t To u rism UPM modeling approach Estimates from sectoral stu d ies and official data High High Not sig ni fi can t Low TO TA L IND IR ECT TAN G IBLE CO ST S i ble t ) t s Social w ater us es Benefit transfer Reasonable/Indicative Reasonable/Indicative Reasonable/Indicative Risk perception Low/D oubtful En v iro nm en t Reasonable/Indicative TO TA L DIR ECT IN TAN G IBLE CO ST S 2,

9 3. 2. Water Economic resouces impacts in LA Direct Impacts Agriculture: Rainfed agriculture Irrigated agriculture Livestock Urban sector: Households welfare Institutional customers Industries/services Parks and street cleaning Tourist sector Energy Environment Indirect Impacts Agrifood sector Food processing industries Ag. Input industries Urban sector business: Hotels, restaurants, bars Tourist industry Golf courses, resources

10 2. Economic impacts Droughts have direct impact on domestic water supply and on water dependant economic sectors, such as irrigation and hydroelectricity production, Agro industry, on water and precipitation dependant, and on other economic activities. Non market impacts include social welfare reductions and impaired environment. The cost of the measures implemented to mitigate, prevent or alleviate the impacts of drought can also be attributable to the economic cost of the drought. Existing information on economic impacts of droughts is scarce, incomplete, unreliable and scattered Drought impacts on natural ecosystems are difficult to value in economic terms.

11 2. Economic impacts Agricultural Impacts Scope Farm i Groups of farms Indirect effects / concers Household s distress Financial difficulties External labour Comarca/county Provincial level Regional level National level Cooperatives distress Local industries Tax receipts Drought insurance Indemnities Reduced GNP

12 2. Economic impacts

13 3. Economic instruments Ex - ante Early stages Drought conditions Critical stage Ex - post Past drought Incentive-based Automatic Agricultural droughts Risk-analysis +Early warning Insurance Indemnities Training, outreach & Preparation Insurance +eligibility Compensatory Emergency Reconstruction Incentive-based Automatic Compensatory Operational droughts Pricing Awareness campaigns Training, outreach & Preparation Spot water markets Optioning rights Allocative Water banks mechanisms Emergency Reconstruction Source: Garrido, A. and A. Gómez-Ramos. Risk Sharing Mechanisms supporting planning and policy En Iglesias, A., A. Cancelliere, F. Cubillo, L.Garrote y D.Wilhite. (Eds.). Coping with Drought Risk in Agriculture and Water Supply Systems. Springer. EEUU

14 3. Economic instruments Conceptual map of the measures applied on agriculture (in Spain) Source: Nuria Hernández Mora, Marina Gil and Alberto Garrido Assessment Report Ebro Case Study Droughts Prempt Project project.net/preempt/

15 4. Virtual water trade Some water shortage combinations foreseen by 2050 GREEN Green shortage Green freedom <1300m 3 /p/yr >1300m 3 /p/yr BLUE Blue shortage <1000m 3 /p/yr Blue freedom >1000m 3 /p/yr a Iran,Pak,Jordan Eg,Eth,India, China c Jap,Bangl,N+SKor, Nga. To, b Kyrg, Czeckosl, Les, S Afr d Zimb,Ghana, Ang,Botsw, Chad,Ke,Mali,Namib, Sud, Ta,Za,Zim b GREEN Some policy implications Green shortage <1300m 3 /p/yr Green freedom >1300m 3 /p/yr BLUE Blue shortage <1000m 3 /p/yr a 46 % of world pop b 14% of world pop Blue freedom >1000m 3 /p/yr horizontal expansion food import radical water productivity increase c 21% of world pop upgrading rainfed agric/ rainwater harvesting d 19% of world pop irrigation expansion upgrading rainfed agric irrigation expansion Flankenmark and Rockstrom in (2011) in Garrido, A. y H. Ingram (Eds). Water for Food in a Changing World. 2 nd Rosenberg Volume Series. Routledge Publishers Londres.

16 4.New irrigation concepts for the 21st century Source: Dalin et al. (PNAS, 109:16, 2012)

17 5. The Role of insurance Agricultural drought risks can be insured against: Considered a systemic risk (expensive reinsurance) Needs subsidies (private sector, reluctant) Technically, more difficult than single peril insurance (Hailstorm

18 5. The Role of insurance Agricultural drought risks can be insured against: Single peril insurance Yield insurance (multiperil insurance) Index insurance Rainfall insurance Satelite insurance Positive Direct Assessment Lower Cost Negative Asym Information Cost Lack of demand Basis risk

19 5. The Role of insurance Problems related to asymmetric information: Due to the differing ability of agents and principal to discern the agents risks because of costly monitoring AGENTS: FARMERS/BORROWERS PRINCIPAL: INSURANCE COMPANIES THE GOVERNMENT Banks Two classical problems

20 5. The Role of insurance No clear evidence of moral hazard problems in agricultural insurance, especially when: With records of individual farmers Index insurance (weather derivatives) With deductibles With bonus-malus With low coverages But, abundant evidence of moral hazard exists in the area of rural banking (especially in cases of public agencies)

21 5. The Role of insurance Two classical problems: Adverse selection: Inability of the insurer to separate low risk from high risk agents. Actuarially Fair premia: Low risk=15 /ha High risk= 35 /ha The whole Area=25 /ha Loss ratios > 1 Low risk High risk Only High risk agents Purchase insurance

22 5. The Role of insurance Problems related to incomplete markets: Market based Agricultural insurance is extremely limited Lack of collateral makes borrowing expensive or impossible (problems of rural banking) Forward contracting is very scarce Poor quality graded and standardisation imposes in situ inspection of harvests

23 شكرا Thank you

THE COMMODITY RISK MANAGEMENT GROUP WORLD BANK

THE COMMODITY RISK MANAGEMENT GROUP WORLD BANK Agricultural Insurance: Scope and Limitations for Rural Risk Management 5 March 2009 Agenda The global market Products Organisation of agricultural insurance