We had an interesting recent economic policy discussion here at QUT about the topical issue of urban water management, chaired by Clevo Wilson, a senior lecturer in environmental economics. The full presentations can be downloaded here. The essence of the debate was whether it would really make sense to try to use price signals to reduce water usage in the big cities like Brisbane, Sydney and Melbourne, a popular topic in econblog land with Andrew Leigh being a vociforous supporter of more aggressive urban water pricing (see, for instance, here).
levo Wilson introduced the background issues involved. The generic issue is that in the region of the major cities, rainfalls have decreased in the last 30 years whilst populations and the water usage per person have massively increased. Whilst urban water users are responsible for no more than about 10% of total human water consumption (the rest goes into agriculture and industry), the urban water system is in many cases geographically separated from the other 2 main users of water in Australia and only at prohibitive costs could they be integrated by long-distance pipelines and the like. There is only a bit of farming that competes with cities for the same water. Clevo explained the main issues in urban water management to be the existence of a natural monopoly in terms of the distribution grid; the variability of demand and supply making marginal costs fluctuate widely; and the existence of other users of the same water (ecosystems) who were not well-funded and would not be able to outbid a city for water. Clevo sketched a water system that was in crisis with strong environmental consequences. There are two basic possibilities for limiting urban water demand: using price signals or appealing to social norms and restrictions. At present, we mainly do the latter.
edzo Mujcic took the classic economic position that we should rely on price signals. Redzo noted that water-tanks were economically inefficient because the implicit value of water out of a water-tank is probably in the region of 2$ per Ml (=1000 liter) , about twice the actual price and above the price of generating water from desalination plants (which cost about 1.70$ per Ml). Redzo found that the literature suggested the demand elasticity to be about -0.4 implying that any serious reduction in water demand would need pretty draconic increases in water prices (you’d need to at least double the total prices of water to halve consumption). Redzo finally noted that a private water supplier would probably over-charge for water because of the natural monopoly, in which case the articifical separation of the water market for urban and proximate rural areas would not be sustainable. Nevertheless, Redzo’s recommendation was to enforce marginal cost pricing on all users of water simultaneously, including the bits of the rural coomunity competing with the city . Because the fluctuations in supply and the importance of geographical location, this would entail a great degree of price differentiation: users in elevated areas would pay more; water would sharply increase in price depending on the level in the dams; there’d be a difference in prices for guaranteed water over the price of water-if-available; areas with more leaky pipes or areas further away from the source would have to pay more; etc. Prices would not necessarily have to rise to meet marginal costs, but rather in order to ensure sufficient capacity for droughts.
emanja Antic on the other hand argued that we should simply give up on marginal cost pricing or any other rpicing scheme because it would be too difficult, be perceived as unfair, would be open to abuse (people illegally tapping into other people’s water), would be open to arbitrage unless we were willing to axe the part of rural Australia close to cities as a viable economic entity that did not recieved water at a lower price than cities. Nemanja’s argument was that an appeal to command and control was the only really viable option, and the most popular option by far in other dry areas of the world too.
I was particularly struck in this debate by the immense complexity of actually pricing urban water and by the quick realisation that the water price increase needed to elicit a sufficiently strong demand reaction would make desalination economically viable. Hence, flexible urban water pricing appears to be an urban myth in terms of being an easy and quick solution. Once we really start to get worried about urban water, we’re simply going to desalinate. As a humurous aside, I foretell that if we do desalinate (and Queensland is already building a plant at Tugun), then we’ll pretend the coal needed to power the electricity station that feeds the very energy-intensive desalination plants is not going to hurt the environment because of the tiny bit of carbon we can put back into the ground (carbon sequestration).