Amer. J. Agr. Econ. 83(4) (November 2001): 958–971 Copyright 2001 American Agricultural Economics Association Recycled Effluent: Should the Polluter Pay? Eli Feinerman, Yakir Plessner, and Dafna M. DiSegni Eshel A coastal city can either dispose of recycled effluent by dumping it in the sea, or transfer it to farmers in its hinterland for irrigation. Who should bear the cost of recycling? Three alternatives are employed: a central planner who maximizes the combined utility of city and farmers; regulation by prices, for which purpose we develop the city’s supply function; and a bargaining framework for the allocation of costs. The main conclusions are that “the polluter pays” rule cannot be justified in principle and that bargaining may result in inefficiency.We demonstrate with an example from Israel that essentially conforms to the theoretical structure. Key words: recycled effluent, city behavior, farmer behavior, cost allocation patterns, institutional arrangements. Recycling has been gaining priority in recent years, to the extent that in some countries, notably Germany, certain types of recycling are now mandated by law.Yet very little has been done in the way of theoretical exami- nation of the economics of recycling. In this article, we propose a theoretical framework for analyzing the recycling of effluent for irri- gation purposes. The importance of recycled effluent is high- lighted by the situation in Israel, a semi- arid country that can use sustainably only 1.9 billion cubic meters (CM) of fresh water annually for all purposes. Of the approx- imately 1 billion CM currently used by agriculture, about 25% (240 million CM) is treated effluent. Since ever increasing amounts of fresh water will have to be diverted from agriculture to household and industrial uses, it is estimated that by the year 2020, 60% of the 1 billion CM used by agriculture will be treated effluent. About 50–60% of the water used for household con- sumption and for industry may be recyclable. The more recycling occurs, the more impor- tant economically becomes the question of how the cost of recycling should be allocated Eli Feinerman and Dafna M. DiSegni Eshel are at the Depart- ment of Agricultural Economics and Management, The Hebrew University of Jerusalem; Yakir Plessner is at the Department of Economics,American University,Washington, D.C. The research underlying this article was partially supported by a grant from the Chief Scientist, Ministry of Agriculture, Israel. We are indebted for helpful comments to Israel Finkelshtain, Yoav Kislev, and two anonymous referees.All remaining follies are our own. between the generators of effluent and the users of the recycled product. In Israel, most policy makers have adopted as a guide for allocation the “polluter pays principle.”Accordingly, the government should set purification standards for disposal, and the city should pay the full processing costs. And where the option for use as irri- gation water exists, the city should purify the water anyway to the level that it would have done if this option did not exist (“the zero alternative”). The farmers ought to receive the purified effluent at the city’s gate at no cost.They should then pay only for transport- ing the water to their fields and for any purifi- cation over and above the level required of the city.Thus, “In the course of the committee’s deliber- ations, pollution factors were identified . Against this background, the committee rec- ommends (a) To adopt the rule ‘the polluter pays’; (b) To carry out an economic analy- sis of the means of implementing [the rule] concerning pollution by urban sewage .” And in order to make clear that “the polluter pays” is not just an Israeli quirk, “In principle, the cost of the zero alternative should be imposed on the effluent’s gener- ator (this principle is accepted in European