This post is the follow-up to yesterday’s post on water infrastructure ownership and management, building on Arnold Kling’s original comment. See also Robert Prather’s post from yesterday, in which he helpfully provides links to his posts on the same subject.
Water is a resource that has multiple uses – human consumption (residential, commercial, and industrial), recreation, sustenance of wildlife, generation of electricity, and so on. As water becomes increasingly scarce relative to our demands for its use, the staggering inefficiency and bureaucratic politicization of its allocation will become more and more costly. Market-based pricing of water use would enable consumers to prioritize their water use and would also promote conservation when it is most needed. It would also encourage increased supply when that supply is most needed, as well as inducing innovators to pursue technological change that would enhance our ability to meet our water needs. In the absence of market-based pricing, as is the case currently, little such activity finds actual commercial application, and does little to benefit society.
In many commercial and residential buildings, water consumers do not see a direct price per gallon of water they use. Charges for water use are frequently bundled into rent, and do not vary when the consumption of water varies. The connection between the use of water and the price the customer pays is either extremely weak or nonexistent in such cases. So we tend to leave the water running while we brush our teeth, use more water than we need to for washing dishes, and have little or no incentive to replace washing machines and dishwashers that use a lot of water with newer technologies that reduce water use.
Even in cases where consumers do pay monthly bills for water, and they do face a per-gallon price, that price usually does not vary when water is more or less scarce. Thus the standard invocation during drought periods to avoid watering your lawn or washing your car, and difficult-to-enforce restrictions on water use on alternate days, and so on.
Why go through such ineffectual and cumbersome machinations when a simpler approach can deliver more bang for the buck? Allowing market pricing of water would serve a variety of objectives. Even municipal water utilities could use dynamic pricing to signal relative scarcity and to induce conservation, so dynamic pricing is a policy that can be applied regardless of company ownership.
Pricing is the most parsimonious way to communicate information on the relative value of and scarcity of something across a large number of unconnected people. The benefits of competitive water markets start with efficient resource allocation through the use of prices to transmit information about prices, costs, and scarcity. Our choices in the face of prices reflect the real value that we place on things, by revealing our decisions in the face of tradeoffs. Price discovery through markets, and the ability to use prices to compare the value of water to other commodities, leads to dynamic efficiency. Thus consumers and producers can see the true tradeoffs among the wide range of potentially conflicting uses of water.
Most importantly, price signals provide simple, straightforward incentives to conserve when that conservation is most needed. Increased water prices would be more effective at reducing the demand for watering the lawn or washing the car than plaintive platitudes about the value of conservation. These market prices therefore provide users with a natural inducement to decrease water use when water is scarce, and therefore to conserve, when water prices rise. Currently, price signals do not exist to enable the movement of water from lower-valued uses to higher-valued uses. These value change over time, and prices allow for flexibility in water allocation that bureaucracies and nationalized industry do not possess.
Indeed, water pricing can be even less complicated than electricity or natural gas pricing, which in its simplest form would require inexpensive interval meters. I think that water does not have the diurnal consumption pattern that electricity has, and that to the extent it does, the peak/off-peak consumption ratio is not as large as you can get in electricity. Thus dynamic pricing over the course of the day may not be the most profitable way to price water, but perhaps day-to-day price changes would be sufficiently dynamic to induce conservation and signal scarcity. Even something as simple as an email saying that starting tomorrow morning at 6 AM, the price of water will increase from X/gallon to Y/gallon until you are informed otherwise would be a simple way to change consumer decisions (although we are not sure by how much, because the lack of actual price changes means that it is hard to estimate the price elasticity of demand for water). In any case, if suppliers thought more creatively about the value proposition they bring to water consumers, they would find pricing terms that would appeal to customers.
An overlooked feature of market-based pricing of water is that it would induce suppliers to make more water available when prices rise, just when the supply is most valuable. The most potent force behind that supply increase is likely to be technological change that can make more water available, such as desalinization. In the current ownership and pricing environment, little incentive exists to explore such technologies except in the most arid and populated areas of the world. Dynamic pricing of water would stir the creativity of entrepreneurs who would see an opportunity to profit from new technologies to treat wastewater and saltwater to make them potable, or at least usable in industrial and agricultural applications. Such a supply would simultaneously reduce strain on the supply of potable water.
This observation raises a related point: water can also be a differentiated product. Not all uses require the quality of water that human consumption requires, and even common infrastructure can transport water that becomes a differentiated product through filtration at the customer interface. As the economies of scale in filtration technology decrease (which has happened over the past decade, with your Brita or PUR as one manifestation), the business model in which suppliers can sell water as a differentiated product becomes even more viable and profitable.
Many barriers exist to such a forward-looking and dynamic approach; customers, both urban and agricultural, have gotten used to a century of subsidized and cheap water, and are not likely to support changes that would improve the efficiency of water allocation and use across the wide range of uses to which we can put water. The benefits of dynamic pricing of water are large but diffuse, and are likely to be sufficiently in the future that any increases in the current water expense of most customers would weigh more heavily in their decisions than would the future benefits of the sustainability of the water supply.
Market-based water pricing enables better allocation of water rights, and optimized use of water, among power generation, consumption, and in-stream flow for recreational and commercial fishing and boating. Continuing to base water policy on open access will lead to overuse, inefficient allocation among those excessive uses, and continuing threats of water scarcity that will endanger both human and aquatic life.