Introduction

The application of economic instruments (EIs) in Latin America has been attempted in several cases following the OECD pattern. However, apart from the failure of accomplishing environmental goals, most of these experiences have also not achieved financing objectives. A recent study by Serôada Motta, Huber and Ruitenbeek (1999) made a strong case on the institutional capacity constraints to apply these instruments in Latin America. This paper will report these findings with more detailed description on the most active EI in the region, namely, water charges. Additionally, it will stress the need of the careful EI design to accommodate institutional capacity with enforcement requirements.

Charging for the use of natural resources has been advocated as a more efficient way to shift the tax burden from “good things,” such as capital and labor, to “bad things,” such as pollution and depletion of natural resources.¹ A few countries have had experience with this shift on a macroeconomic basis, particularly with air pollution in the Scandinavian countries.²

Such a shift is not a trivial matter, however. It depends on a sound fiscal system and also on good environmental monitoring and enforcement of regulations to make the shift viable. These experiences may not, therefore, be an immediately useful benchmark for Latin American countries.

The economic literature tends to regard economic instruments (EIs) as a more efficient way to achieve environmental goals than the quantitative and technological options commonly denominated command-and-control mechanisms (CAC).³ However, not only is the choice of an appropriate economic instrument theoretically complex, but experience with the application of these instruments is full of controversy about their effectiveness in striking the proposed environmental targets. Nevertheless, there are plenty of examples in the literature on the use of EIs to raise revenue to fund environmental programs and projects and/or to finance environmental management services, and there have been a number of successes, particularly in the OECD countries.⁴

In Latin America, the application of EIs based on OECD experience has been attempted in several cases. However, apart from the failure to accomplish environmental goals, most of these experiences have not achieved financing objectives.

A recent study by Serôada Motta, Huber, and Ruitenbeek (1999) makes a strong case that institutional capacity places constraints on the use of EIs in Latin America. This paper will report these findings with a more detailed description of the most active EI in the region: water charges. Additionally, it will stress the need for careful design to accommodate institutional capacity presenting detailed guidelines for EI formulation.

The first section summarizes a conceptual framework for EIs. Next comes a summary of the main EI experiences in Latin America, followed by a section devoted to water charges. Finally, conclusions are presented.