User pays would help alleviate water shortages

User pays would help alleviate water shortages

The recent hot summer has not only been badfor my skin, but for famers as well.   A drought has reduced production ofagricultural goods, undermining a major source of New Zealand export income.   Furthermore,growth in both the number of people and cows has begun to stretch the waterinfrastructure in some regions, suggesting that a longer-term problem of watershortages beckons.   When an economist hears the word shortage there is onething we think – put the price up.   So it is about time we set a price forwater, by establishing a market.

One counter-argument for using a price isthat there is already a "moral cost" for overusing water.   If we create a pricefor water then people may ignore these moral costs on the basis that they canafford to overuse water, and so may worsen the incidence of water wastage.

In all honesty though, who can say thatthey are as careful with their water consumption as they would be if they hadto pay for it?   I get the feeling that a lot of leaky taps would be fixed, longshowers avoided, and marginal farm irrigation projects shelved if people had topay the true cost of the water they use.

The purpose of pricing a good is to ensureits value is clearly represented.   Setting an appropriate price would ensurethat the allocation of water is efficient, rather than relying on vague moralcosts.

In the case of water, however, publicopposition to a price is likely to be intense, with the belief that water is anecessity and people should not be charged for it.   If we are concerned thatthe poor will not be able to afford to buy enough water, policymakers could seta price for water and then give everyone sufficient money or vouchers to buy a "necessary"amount of water.   Under such a scheme, the price of water beyond this freeallocation would be higher relative to other goods in the economy than it isnow, and people would buy less – and certainly not all current waterconsumption is necessary!

However, before a price for water can beestablished, a market for water is required.   A market for water is just a termfor the interaction between groups of buyers and sellers of water.

According to René Le Prou, an industrial economistat LECG, there are three distinct ways we could structure the market for water.

  1. Public provision, where the market price is estimated by the government
  2. Some form of public-private partnership, where the government is involved in the construction of the infrastructure, but a private company sets the price
  3. Sell (or hand out) the property rights for water to private groups and allow them to build infrastructure and set prices

Each possibility comes with different costsand benefits that would need to be analysed before any such market could beestablished.   However, all three of these methods have one thing in common –they require a clear definition of "property rights" surrounding water.

Property rights are essential for a pricingsystem to work.   If no one owns the property, no one can stop other people justtaking the resource for free.   In the case with clearly defined propertyrights, the owner of the resource has the incentive to "conserve" it.   As wateris storable (at a cost), there would be an incentive for the owner of the waterresource to save water during wet periods to use during dry times – as thevalue of water rises during a drought.   This type of behaviour would help toalleviate the impact of short-term changes in weather, like the sunny days wehave experienced recently.

Changes to the market price also provide atimely signal of changes in demand.   If the price holds up for a significantamount of time, it provides an incentive for the owner of the water resource toexpand supply, by finding other sources of water.   In this case, potential infrastructuralproblems may be overcome.

Water, the elixir of life, is too importantto provide on a "first in, first served" basis as we do currently.   Theestablishment of an appropriate market mechanism is the best way to ensure thatour scarce water is allocated in the most efficient way possible.


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