Water Economics

The coming century will prominently feature the increasing threat of water scarcity. This threat will take the form of a series of interlinked challenges, which share the common theme of how to match scarce water supplies to a growing set of uses, but feature different challenges in managing supply and demand. Each situation then has its own policy responses, but can draw on common principles for effective management. Consider the two prominent examples of urban water management and agricultural water management.

The Economics of Urban Water Management

The first response to urban water shortages, and the one that often appeals to public officials, is to focus on increasing the amount of water available, which is possible with significant public investment. In the face of water shortages, cities around the world have spent sizeable fractions of their budgets on larger dams, desalination plants and community or individual supplies such as subsidies for rainwater tanks.

Due to the cost of public investment, there is a growing awareness of the need to view urban supply from a portfolio perspective. The various options available have different risk and cost profiles, and the ideal combination blends low cost but variable supply options, such as dams, with high security but high cost options, such as desalination. This shift to portfolio theory offers the possibility of both higher reliability and lower cost than any individual supply technology alone.

In the long run, however, any suite of supply options needs to be supplemented with demand management. Traditionally, the primary approach to water conservation has been prescriptive regulation, such as rationing of water for particular uses and at particular times of day or week, and requirements for the installation of particular technologies. These are often complemented with a range of softer encouragements of lower water use, such as education programs or exhortations to take shorter showers. Such programs have been modestly effective in the past (a good summary is provided here).

Taking encouragement from the shift towards market-based policies in pollution control, environmental economists are increasingly calling for the use of higher water prices as a means of further encouraging conservation. The appeals of such a tactic include the relative ease of monitoring and enforcement, but at a deeper level reflect the intuition that in the long-run it is often more effective and efficient to give people reasons to save water, and then let them decide how it is to be done, than to prescribe any one particular approach. Evidence suggests that market based mechanisms achieve conservation targets at a lower cost than command-and-control measures.

One reason why price-based approaches are not common is opposition on distributional grounds and the belief that free or cheap access to water is a basic human right. In a well-designed system, however, there is no fundamental incompatibility between price-mechanisms and basic entitlements to water — for example, it is possible to guarantee a minimum enforceable allocation, and have increasing block tariffs for use above that level. Equity can still be a goal of policy without abandoning price as a tool, particularly where it can be supplemented with other reforms, such as improvements to the welfare system, that support the most seriously affected.

Water for Food and Farming

The combination of relatively fixed supply, particularly once river systems are well-dammed, and fewer, more sophisticated users makes the challenges facing agricultural and rural water management those of market design, rather than tradeoffs between service and cost. Across the world, the pattern of governance has typically been that access to rivers, aquifers and other sources was granted very generously to encourage development. However, as the number of users and the amount diverted has increased, and hydrography and climate have changed, this has lead to over-allocation (over use) and the risk of exhausting ground water supplies. The modern challenge is therefore shepherding overstretched systems by developing effective allocation mechanisms.

Having acknowledged that river systems have become over-allocated, governments have acted to restrict usage to some fixed level. However, while refusing to issue new usage rights and retiring old or unused rights prevent further over-exploitation, it does little to encourage more effective use of the water remaining. As a result, some jurisdictions have allowed rights holders to sell or lease their water rights to other users, and in other jurisdictions trading of this type happens informally. This has three main benefits. The first occurs at the time of reform: it allows users to shift in or out of intensive water use, without having to buy water and land together as a bundle, which is typically the status quo ante. Secondly, on a year-to-year or season-to-season basis it enables users who use very large amounts of water per unit, such as the growers of water-intensive crops like rice and cotton, to use their entitlements when water is plentiful, and to rent them in times of drought to users who need a much more consistent level of water across seasons, such as vineyards and horticulturalists. Where cities and agricultural areas share a common watershed, marginal agricultural water users can potentially sell their rights to urban water users when municipal water supplies run low. Finally, in the longer term water trading encourages patterns of water use to shift from low-value to high-value uses in response to changing conditions. Trading systems have been set up in Australia, Chile and elsewhere, with varying but generally positive levels of success.

Creating markets of this nature is not straightforward, however. Effective trading systems require that water rights are well defined and easily traded, a difficult task in the absence of robust legal system and cost-effective means of assessing usage. Alongside the fundamental legal and economic problems, geography can play a significant role. In regions in which a significant amount of a river’s flow is returned water from diversions further upstream, adjudicating the clash between commercial efforts at conservation, which reduce those return flows, and downstream users has lead to tensions. Similarly, while effectively delivering water on demand is possible in well-regulated rivers, in steeper or less dammed rivers users may simply have to take water when it is available, rather than when they are entitled to it.

Even in well-functioning market systems there can be serious policy obstacles. One of the most prominent is protecting non-commercial public uses of water, in particular environmental flows, when usage rights are openly tradable. The natural solution is for the state to act as guarantor of those interests, purchasing water specifically to leave it in the river system or using it to flood important ecosystems (in Australia, a separate government agency has been created for this purpose). However, efforts at conservation of this type have lead to tensions with rural and agricultural communities, who feel that their traditional way of life is under threat.

Good policy, bad policy

While the challenges and regulatory opportunities vary across sectors and uses, there are common themes for the effects and characteristics of poor management and effective management. The effects of poor water policy can be dramatic: drought, thirst, and crop failure. More generally, however, the cost comes in the form of wasted resources. In the urban sector, supply facilities are often built at great public expense because demand management is not taken seriously. In the agricultural sector, much production is lost because water is trapped in unproductive uses, while vital public assets such as marshlands and marine ecosystems slowly die. In the longer term, mismanagement of water can ruin once-productive areas — for example, the area around Russia’s Aral Sea, once a fertile cotton producing area, is now effectively a desert.

On the other hand, getting water policy right means getting water to the right people, at the right times, sustainably. A key part of this is striking the balance between flexibility, to avoid today’s policy solutions from locking in particular reform-resistant interests (a problem that has plagued efforts at agricultural water reform), and certainty for users so they can invest in the future confidently and effectively. Another crucial tradeoff is basing policy on the best scientific evidence while not shying away from the fact that ultimately these are political questions. Science can offer an assessment of the environmental and sustainability costs of water use, but cannot weigh those costs against social objectives. The consideration of various incommensurable costs and benefits is necessarily a role for public officials.

Ultimately, effective water management must be imbedded in a system of active, well-engaged regulators and users. Good policy will empower users to make conservation decisions on their own, by augmenting private information with messages of collective scarcity through a combination pricing, legal rights protections, education and dialogue between users and suppliers. To tackle challenges as they arrive, active regulators will be aware that policy is necessarily iterative, and that each solution sets up the conditions for the next set of challenges. The past few decades have seen the start of a movement away from passive and static users and policy, but a greater shift will be needed. While the future of water management may seem gloomy, effective policy that can deliver mutual gain is possible. To solve the water problems of the coming century, good governance will be just as important as, if not more important than, good engineering.

Image Credit: By Rocknross52 (Own work) [CC-BY-SA-3.0 (http://creativecommons.org/licenses/by-sa/3.0)], via Wikimedia Commons


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